Eco403 Mid Term Notes

MacroeconoMics
eco 403
MiD TerM noTes
MaDe by: Muniba ch
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Lesson 01
INTRODUCTION TO MACROECONOMICS
MCQs:
1. What are the two major branches in economics?
a. Microeconomics
b. Macroeconomics
c. Both a and b
d. None of the above
Answer: c. Both a and b
2. Which of the following is a key economic variable studied in Macroeconomics?
a. Individual income
b. Unemployment
c. Microeconomic supply
d. Price elasticity
Answer: b. Unemployment
3. What is the primary focus of Macroeconomics?
a. Study of individual markets
b. Study of aggregate economic variables
c. Both a and b
Answer: b. Study of aggregate economic variables
4. The likely response of key economic variables to public policies is studied in:
a. Microeconomics
b. Macroeconomics
c. Both a and b
Answer: b. Macroeconomics
5. What is the objective of studying macroeconomics?
a. Understanding individual consumer choices
b. Learning how the national economy works
c. Both a and b
Answer: b. Learning how the national economy works
6. Which of the following is a long-run economic variable?
a. Aggregate Demand
b. Unemployment
c. Economic Growth
d. Govt. Debt
Answer: c. Economic Growth
7. What does scarcity mean in economics?
a. Abundance of resources
b. Limited resources
c. Equal distribution of resources
Answer: b. Limited resources

8. What is the study of how society manages its scarce resources?
a. Sociology
b. Anthropology
c. Economics
d. Political Science
Answer: c. Economics
9. What is the cost of something in economics?
a. Its market price
b. Its production cost
c. What you give up to get it
Answer: c. What you give up to get it
10. The word "economy" originates from a Greek word meaning:
a. Market
b. Household management
c. Trade
d. Production
Answer: b. Household management
11. What does rational decision-making involve in economics?
a. Emotional choices
b. Margin thinking
c. Random decisions

Answer: b. Margin thinking
12. What is the short-run tradeoff that society faces according to the principles of
economics?
a. Trade restrictions and free trade
b. Inflation and unemployment
c. Aggregate Demand and Aggregate Supply
d. Government budget deficit and surplus
Answer: b. Inflation and unemployment
13. According to the principles of economics, how does society manage its resources?
a. By avoiding tradeoffs
b. By maximizing production
c. By making rational decisions
Answer: c. By making rational decisions
14. What is the primary focus of Microeconomics?
a. Aggregate economic variables
b. Individual markets and choices
c. Macroeconomic policies
Answer: b. Individual markets and choices
15. What determines the standard of living in a country according to economic

principles?
a. Government policies
b. Aggregate Demand
c. Country's production
d. Inflation rate
Answer: c. Country's production
16. What is the role of markets in organizing economic activity according to economic
principles?
a. Inefficient
b. Usually a good way
c. Unnecessary
d. Harmful
Answer: b. Usually a good way
17. According to economic principles, when does the price rise?
a. During economic growth
b. When the government prints too much money
c. During recession
Answer: b. When the government prints too much money
18. What is the relationship between prices and money supply according to economic
principles?
a. Inverse relationship
b. Direct relationship
c. No relationship
d. Random relationship
Answer: b. Direct relationship
19. What is the study of how people interact with each other in economic terms?
a. Sociology
b. Microeconomics
c. Macroeconomics
d. Anthropology
Answer: c. Macroeconomics
20. According to economic principles, what is the role of government in improving

economic outcomes?
a. Always beneficial
b. Sometimes beneficial
c. Always detrimental
d. No role
Answer: b. Sometimes beneficial
Q&A:
1. What are the two major branches of economics?
o A: Microeconomics and Macroeconomics.
2. What does Macroeconomics study?
o A: Macroeconomics studies the determinants and movements of key economic
variables such as unemployment, inflation, interest rates, and more.
3. What is the primary objective of studying Macroeconomics?
o A: The objective is to help understand how the national economy works.
4. Name some key economic variables studied in Macroeconomics.
o A: Unemployment, inflation, interest rates, exchange rates, productivity, growth,
government budget deficit/surplus, foreign trade deficit.
5. In Macroeconomics, what do we study the likely response of key economic variables
to?
o A: Public policies such as fiscal policy, monetary policy, trade policies, etc.
6. Why is the study of Macroeconomics important?
o A: It helps in understanding issues like the present levels of key economic
variables, their likely future paths, causes and consequences of recessions,
inflation, etc.
7. What is the scope of Macroeconomics?
o A: The scope includes the study of macroeconomic data and its measurement.
8. What are some topics covered in the Economy in the Long Run section of the
course?
o A: National Income, Economic Growth, Unemployment, Money and Inflation,
Open Economy.
9. What is the short-run tradeoff that society faces according to economic principles?
o A: The tradeoff is between inflation and unemployment.
10. According to the Ten Principles of Economics, what is scarcity?
o A: Scarcity means that society has limited resources and cannot produce all the
goods and services people wish to have.
11. What does the term "economy" mean, and what is its origin?
o A: Economy comes from a Greek word for "one who manages a household."
12. What is the study of how society manages its scarce resources called?
o A: Economics.
13. According to economic principles, what is the cost of something?
o A: The cost is what you give up to get it.
14. How do rational people make decisions according to economic principles?
o A: Rational people think at the margin.
15. What is the role of trade in economic interactions according to economic principles?
o A: Trade can make everyone better off.
16. What is the usual role of markets in organizing economic activity according to
economic principles?
o A: Markets are usually a good way to organize economic activity.
17. How can governments improve economic outcomes according to economic
principles?
o A: Governments can sometimes improve economic outcomes.
18. According to economic principles, what does the standard of living depend on?
o A: The standard of living depends on a country's production.
19. When do prices rise according to economic principles?
o A: Prices rise when the government prints too much money.
20. According to economic principles, what is the short-run tradeoff society faces?
o A: Society faces a short-run tradeoff between inflation and unemployment.
Lesson 02
PRINCIPLES OF MACROECONOMICS
MCQs:
1. What is the main idea behind Principle #1: "People Face Tradeoffs"?
a. There is always a free lunch
b. Decisions involve trading off one goal against another
c. People should not make tradeoffs

d. Tradeoffs do not exist
Answer: b. Decisions involve trading off one goal against another
2. Efficiency in an economy means:
a. Fair distribution of resources
b. Maximizing benefits from scarce resources
c. Minimizing benefits from scarce resources
d. Ignoring tradeoffs
Answer: b. Maximizing benefits from scarce resources
3. What does Principle #2 state about the cost of something?
a. The cost is what you give up to get it
b. The cost is always monetary
c. The cost is fixed
d. The cost is irrelevant
Answer: a. The cost is what you give up to get it
4. Opportunity cost is:
a. The monetary cost of an item
b. The next best alternative given up to obtain an item
c. Always zero
d. Unimportant in decision-making
Answer: b. The next best alternative given up to obtain an item
5. According to Principle #3, how do rational people think?
a. At the maximum
b. At the minimum
c. At the margin
d. Emotionally
Answer: c. At the margin
6. What motivates people to respond, according to Principle #4?
a. Fixed costs
b. Marginal changes in costs or benefits
c. Sunk costs
d. Ignoring costs
Answer: b. Marginal changes in costs or benefits
7. According to Principle #5, how can trade impact individuals?
a. It has no impact
b. It can make everyone worse off
c. It can make everyone better off
d. Trade has no connection with individuals
Answer: c. It can make everyone better off
8. What is a market economy?
a. An economy with no markets
b. An economy with centralized decisions
c. An economy that allocates resources through decentralized decisions in markets
d. An economy without firms
Answer: c. An economy that allocates resources through decentralized decisions in

markets
9. According to Principle #7, what is a cause of market failure?
a. Efficient allocation
b. Externality
c. Market power is desirable
d. Government intervention
Answer: b. Externality
10. The "invisible hand" concept is associated with:
a. Adam Smith
b. Karl Marx
c. John Maynard Keynes
d. Milton Friedman
Answer: a. Adam Smith
11. What does the Phillips Curve illustrate?
a. The tradeoff between inflation and unemployment
b. The tradeoff between inflation and interest rates
c. The tradeoff between income and prices
d. The tradeoff between consumption and savings
Answer: a. The tradeoff between inflation and unemployment
12. What is the main focus of Principle #8?
a. Government intervention in markets
b. Personal incomes
c. Differences in countries’ productivities
d. The overall level of prices in the economy
Answer: c. Differences in countries’ productivities
13. What is inflation?

a. Decrease in the overall level of prices
b. Increase in the overall level of prices
c. Stable prices
d. Government intervention
Answer: b. Increase in the overall level of prices
14. According to Principle #9, what causes inflation?
a. Decrease in the quantity of money
b. Stability in the quantity of money
c. Growth in the quantity of money
d. No relation to the quantity of money
Answer: c. Growth in the quantity of money
15. What does the Phillips Curve depict in terms of inflation and unemployment?
a. Long-run tradeoff
b. No tradeoff exists
c. Short-run tradeoff
d. Tradeoff between interest rates and prices
Answer: c. Short-run tradeoff
16. According to Principle #10, what does the standard of living depend on?
a. Government policies
b. A country's production
c. Population size
d. Currency value
Answer: b. A country's production

17. How is productivity measured?
a. By comparing personal incomes
b. By comparing the total market value of a nation’s production
c. By comparing prices
d. By comparing trade balances
Answer: b. By comparing the total market value of a nation’s production
18. What is the impact of government printing too much money, according to Principle
#9?
a. Decrease in prices
b. Increase in prices
c. No impact on prices
d. Stable prices
Answer: b. Increase in prices
19. What does Principle #6 suggest about markets?
a. Markets lead to inefficiency
b. Markets are an inefficient way to organize economic activity
c. Markets are a good way to organize economic activity
d. Markets are irrelevant
Answer: c. Markets are a good way to organize economic activity
20. What is the role of governments according to Principle #7?
a. Always interfere with markets
b. Improve market outcomes
c. Have no impact on markets
d. Cause market failure

Answer: b. Improve market outcomes
Q&A:
1. What does Principle #1, "People Face Tradeoffs," imply?
o Answer: It suggests that in decision-making, individuals must give up one thing to
obtain another, and tradeoffs are inevitable.
2. Define efficiency and equity as mentioned in Principle #1.
o Answer: Efficiency means obtaining the most from scarce resources, while equity
refers to the fair distribution of benefits among society members.
3. According to Principle #2, what is the cost of something?
o Answer: The cost of something is what you give up to get it, known as the
opportunity cost.
4. Provide examples of tradeoffs mentioned in Principle #1.
o Answer: Examples include guns vs. butter, food vs. clothing, leisure time vs.
work, and efficiency vs. equity.
5. How does Principle #3 describe rational decision-making?
o Answer: Rational people make decisions at the margin, considering small
incremental changes and comparing costs and benefits.
6. What motivates individuals to respond, according to Principle #4?
o Answer: People respond to incentives, specifically marginal changes in costs or
benefits.
7. Explain how trade, according to Principle #5, can benefit everyone.
o Answer: Trade allows people to specialize, resulting in gains from trading and
making everyone better off.
8. According to Principle #6, why are markets considered a good way to organize
economic activity?
o Answer: Markets allocate resources efficiently through the decentralized
decisions of firms and households, guided by the "invisible hand."
9. Who observed the concept of the "invisible hand," and what does it imply?
o Answer: Adam Smith observed it; the invisible hand implies that individuals, by
pursuing self-interest in markets, unintentionally promote the overall welfare of
society.
10. When does government intervention become necessary, according to Principle #7?
o Answer: Government intervention is needed when market failure occurs,
preventing efficient resource allocation. Examples include externalities and
market power.
11. How does Principle #8 connect a country's production to the standard of living?
o Answer: The standard of living depends on a country's production, with
productivity measured by the amount of goods and services produced per worker's
hour.
12. What is inflation, according to Principle #9, and what causes it?
o Answer: Inflation is an increase in the overall level of prices, caused by the
government printing too much money, leading to a decrease in its value.
13. Explain the short-run tradeoff mentioned in Principle #10.
o Answer: The Phillips Curve illustrates a short-run tradeoff between inflation and
unemployment; as inflation decreases, unemployment increases.
14. How does Principle #10 highlight the interrelation between inflation and
unemployment?
o Answer: The Phillips Curve illustrates that there is a short-run tradeoff between
inflation and unemployment; as inflation decreases, unemployment tends to
increase.
15. What factors may cause market failure, according to Principle #7?
o Answer: Market failure may be caused by externalities (impacts on bystanders)
and market power (undue influence on market prices by an individual or firm).
16. How is productivity measured, according to Principle #8?
o Answer: Productivity is measured by the amount of goods and services produced
from each hour of a worker’s time.
17. According to Principle #9, why do prices rise?
o Answer: Prices rise when the government prints too much money, leading to
inflation.
18. In terms of tradeoffs, what does Principle #1 suggest about decision-making?
o Answer: Principle #1 suggests that decisions involve trading off one goal against
another, emphasizing the inevitability of tradeoffs in decision-making.
19. How does Principle #4 describe the decision-making process?
o Answer: Principle #4 states that people respond to incentives, and the decision to
choose one alternative over another occurs when the alternative's marginal
benefits exceed its marginal costs.
20. What role does the "invisible hand" play in market economies, according to
Principle #6?
o Answer: The "invisible hand" in market economies guides decision-makers to
outcomes that tend to maximize the welfare of society as a whole, as households
and firms consider prices in their decisions.
Lesson 03
IMPORTANCE OF MACROECONOMICS &
ECONOMIC MODELS
MCQs:
1. Why is the cost of living rising?
a. Government intervention
b. Market competition
c. Economic models
d. Not mentioned
Answer: d. Not mentioned
2. What is a key question about unemployment during economic booms?
a. Why is there inflation?
b. Why is there a trade deficit?
c. Why are people unemployed?
d. Not mentioned
Answer: c. Why are people unemployed?
3. What does the government budget deficit impact?
a. Inflation
b. Employment
c. Economic growth
d. All of the above
Answer: d. All of the above
4. What is a common issue discussed in macroeconomics?
a. Microeconomics
b. Unemployment
c. Individual preferences
Answer: b. Unemployment
5. What does the Phillips Curve illustrate?
a. Trade deficit and inflation
b. Short-run tradeoff between inflation and unemployment

c. Economic growth and unemployment
d. Not mentioned
Answer: b. Short-run tradeoff between inflation and unemployment
6. What is the purpose of economic models?
a. To complicate reality
b. To simplify reality
c. To ignore economic variables
d. Not mentioned
Answer: b. To simplify reality
7. What are endogenous variables in economic models?
a. Variables determined outside the model
b. Variables identified within the model
c. Independent variables
Answer: b. Variables identified within the model
8. What do sticky prices refer to in macroeconomics?
a. Prices that adjust quickly in response to market changes
b. Prices that adjust slowly in response to market changes
c. Fixed prices
d. Not mentioned
Answer: b. Prices that adjust slowly in response to market changes
9. What does a flexible price mean in the context of macroeconomics?
a. Prices that never adjust

b. Prices that adjust quickly
c. Prices that are always fixed
d. Not mentioned
Answer: b. Prices that adjust quickly
10. In the model of supply and demand for new cars, what is an endogenous variable?
a. Aggregate income (Y)
b. Quantity demanded (Qd)
c. Price of steel (Ps)
d. Not mentioned
Answer: b. Quantity demanded (Qd)
11. What does the upward-sloping supply curve and downward-sloping demand curve
give rise to?
a. Market shortage
b. Market equilibrium
c. Market surplus
d. Not mentioned
Answer: b. Market equilibrium
12. What does an increase in income do to the quantity of cars demanded and the
equilibrium price?
a. Increases quantity demanded, decreases equilibrium price
b. Decreases quantity demanded, increases equilibrium price
c. Increases quantity demanded, increases equilibrium price
d. Not mentioned
Answer: c. Increases quantity demanded, increases equilibrium price

13. What does an increase in the price of steel do to the quantity of cars supplied and
the market price?
a. Increases quantity supplied, increases market price
b. Decreases quantity supplied, decreases market price
c. Increases quantity supplied, decreases market price
d. Not mentioned
Answer: c. Increases quantity supplied, decreases market price
14. What is an example of an exogenous variable in the model of supply and demand for
new cars?
a. Price of new cars
b. Quantity demanded
c. Aggregate income (Y)
d. Not mentioned
Answer: c. Aggregate income (Y)
15. Why do macroeconomists use economic models?
a. To complicate economic understanding
b. To simplify economic understanding
c. To ignore economic issues
d. Not mentioned
Answer: b. To simplify economic understanding
16. Which of the following is a consequence of an increase in unemployment rate, as

mentioned in the text?
a. Decrease in domestic violence
b. Increase in mental health
c. Decrease in homicides
d. Not mentioned
Answer: c. Decrease in homicides
17. How does the macroeconomy affect politics and current events?
a. It has no impact on politics
b. It affects inflation but not unemployment
c. It affects inflation and unemployment in election years
d. Not mentioned
Answer: c. It affects inflation and unemployment in election years
18. What is the main concern of the Phillips Curve?
a. The relationship between inflation and unemployment
b. The relationship between inflation and interest rates
c. The relationship between inflation and GDP
d. Not mentioned
Answer: a. The relationship between inflation and unemployment
19. What do flexible prices mean for the long-run aggregate supply curve?
a. It is horizontal
b. It is vertical
c. It is upward-sloping
d. Not mentioned
Answer: b. It is vertical
20. What is the primary reason underlying the positive slope of the short-run aggregate
supply curve?
a. Sticky prices
b. Flexible prices
c. Market equilibrium
d. Not mentioned
Answer: a. Sticky prices
Q&A:
1. Why does the cost of living keep rising?
o Answer: The cost of living rises due to factors such as inflation, increased
demand for goods and services, and changes in economic conditions.
2. What is a key concern during economic booms regarding unemployment?
o Answer: Despite economic booms, millions of people may remain unemployed
due to various factors like structural unemployment, skills mismatch, and cyclical
economic fluctuations.
3. What is the impact of recessions on society, and can the government combat them?
o Answer: Recessions lead to increased unemployment, reduced economic activity,
and social challenges. Governments can implement fiscal and monetary policies
to counteract recessions.
4. Explain the concept of the government budget deficit and its effects on the economy.
o Answer: The government budget deficit occurs when expenditures exceed
revenues. It can lead to increased public debt, potentially affecting interest rates
and overall economic stability.
5. Why do economies often have significant trade deficits?
o Answer: Trade deficits may arise from imbalances in exports and imports, driven
by factors like differences in production costs, currency values, and global
economic conditions.
6. What are some reasons why many countries are poor, and what policies might help
them grow out of poverty?
o Answer: Factors contributing to poverty include lack of education, political
instability, and limited access to resources. Policies such as education reform,
infrastructure development, and targeted aid can aid in poverty alleviation.
7. How does the macroeconomy impact society's well-being, as mentioned in the text?
o Answer: The macroeconomy, particularly unemployment, is linked to social
problems. For instance, an increase in the unemployment rate is associated with
higher rates of suicides, homicides, mental health issues, and homelessness.
8. How does the macroeconomy affect individuals' well-being, considering factors like
unemployment, earnings growth, and interest rates?
o Answer: Macroeconomic factors impact individuals' well-being by influencing
unemployment rates, earnings growth, and financial conditions such as interest
rates and mortgage payments.
9. Discuss the relationship between inflation and unemployment during election years.
o Answer: In election years, there is often a relationship between inflation and
unemployment. The text provides data showing how these two factors vary in
different election years.
10. Explain the purpose of economic models in macroeconomics.
o Answer: Economic models are simplified representations of reality used to show
relationships between economic variables, explain economic behavior, and devise
policies to improve economic performance.
11. Describe the model of supply and demand for new cars and its assumptions.
o Answer: The model assumes a competitive market where each buyer and seller is
too small to affect the market price. Variables include quantity demanded (Qd),
quantity supplied (Qs), price of new cars (P), aggregate income (Y), and price of
steel (Ps).
12. What does the demand curve show in the context of the model for new cars?
o Answer: The demand curve illustrates the inverse relationship between the
quantity of cars demanded and the price, assuming other factors remain constant.
13. How does an increase in income affect the equilibrium price and quantity of cars?
o Answer: An increase in income leads to an increase in the quantity of cars
demanded at each price, resulting in an increase in both equilibrium price and
quantity.
14. Explain the effects of an increase in the price of steel on the quantity of cars
supplied and the market price.
o Answer: An increase in the price of steel reduces the quantity of cars supplied at
each price, leading to an increase in market price and a decrease in quantity.
15. Differentiate between endogenous and exogenous variables in economic models.
o Answer: Endogenous variables are determined within the model and are
dependent variables, while exogenous variables are determined outside the model
and are independent variables.
16. How do flexible prices and sticky prices impact macroeconomic analysis?
o Answer: Flexible prices mean adjustments in the long run, influencing long-run
macroeconomic activity. Sticky prices, on the other hand, lead to short-run
fluctuations, especially in resource markets.
17. Why are flexible prices crucial for the vertical slope of the long-run aggregate
supply curve?
o Answer: Flexible prices are essential for the vertical slope of the long-run
aggregate supply curve because they allow prices to adjust, ensuring market
equilibrium in the long run.
18. What is the primary reason underlying the positive slope of the short-run aggregate
supply curve?
o Answer: The positive slope of the short-run aggregate supply curve is primarily
due to sticky prices, meaning that prices adjust slowly in response to market
changes.
19. How do macroeconomists address different macroeconomic issues through models?
o Answer: Macroeconomists use a variety of models to study and address different
macroeconomic issues. These models help analyze relationships between
variables and devise policies for economic improvement.
20. Why is understanding macroeconomics important for individuals, society, and
policymakers?
o Answer: Macroeconomics affects individuals by influencing employment,
earnings growth, and financial conditions. It impacts society through social
problems associated with economic conditions, and policymakers use
macroeconomic understanding to devise effective policies.
Lesson 04
NATIONAL INCOME ACCOUNTING
MCQs:
1. What is Gross Domestic Product (GDP)?
a) The total value of imported goods and services
b) The total market value of all goods and services produced within the political boundaries of an
economy
c) The total income earned by foreign factors of production
d) The total expenditure on foreign-produced final goods and services
Answer: b) The total market value of all goods and services produced within the political
boundaries of an economy
2. Why is "Expenditure = Income" in the circular flow of income?
a) Buyers always spend more than their income
b) Sellers earn more income than they spend
c) In every transaction, the buyer’s expenditure becomes the seller’s income
d) Expenditure and income are unrelated in economic transactions
Answer: c) In every transaction, the buyer’s expenditure becomes the seller’s income
3. What is the rule regarding the computation of GDP for used goods?
a) Used goods are included in the calculation of GDP
b) Used goods are excluded from the calculation of GDP
c) Used goods are counted twice in the calculation of GDP
d) Used goods are only considered if they are of high value

Answer: b) Used goods are excluded from the calculation of GDP
4. How is the value added of a firm calculated?
a) It is equal to the total revenue of the firm
b) It is equal to the total cost of production
c) It is the value of the firm’s output less the value of the intermediate goods the firm purchases
d) It is the total profit of the firm
Answer: c) It is the value of the firm’s output less the value of the intermediate goods the
firm purchases
5. Which of the following is NOT counted in GDP?
a) Intermediate goods
b) Final goods
c) Used goods
d) Imported goods
Answer: a) Intermediate goods
6. What is the distinction between Nominal GDP and Real GDP?
a) Nominal GDP includes only goods, while Real GDP includes goods and services
b) Nominal GDP is measured at constant prices, while Real GDP is measured at current prices
c) Nominal GDP is the value of final goods measured at current prices, while Real GDP is
measured using a constant set of prices
d) Nominal GDP is adjusted for inflation, while Real GDP is not
Answer: c) Nominal GDP is the value of final goods measured at current prices, while Real
GDP is measured using a constant set of prices
7. What does Real GDP represent?
a) The total market value of goods and services
b) The value of goods and services measured using a constant set of prices
c) The total income earned in an economy
d) The total expenditure on domestically-produced final goods
Answer: b) The value of goods and services measured using a constant set of prices
8. How is Nominal GDP calculated?
a) Nominal GDP = Real GDP / Price level
b) Nominal GDP = Price level x Real GDP
c) Nominal GDP = Expenditure - Income
d) Nominal GDP = Value added
Answer: b) Nominal GDP = Price level x Real GDP
9. What is the purpose of using imputed values in GDP calculation?
a) To overestimate the value of goods and services
b) To exclude non-market activities from GDP
c) To estimate the value of goods and services with no market prices
d) To reduce the overall GDP
Answer: c) To estimate the value of goods and services with no market prices
10. In GDP computation, how are inventories treated?
a) Inventories are always included in GDP
b) Treatment of inventories depends on whether the goods are stored or spoil
c) Inventories are excluded from GDP
d) Inventories are counted twice in GDP
Answer: b) Treatment of inventories depends on whether the goods are stored or spoil
11. Which of the following is included in GDP as an imputed value?
a) The salary of a factory worker

b) The rent paid by a homeowner to themselves
c) The price of a car sold in the marketplace
d) The cost of a service provided by a private company
Answer: b) The rent paid by a homeowner to themselves
12. What is the purpose of using real units in GDP calculation?
a) To eliminate the problems created by having a measuring stick that changes length over time
b) To increase the overall GDP value
c) To make the GDP calculation more complex
d) To adjust for changes in consumer preferences
Answer: a) To eliminate the problems created by having a measuring stick that changes
length over time
13. What does the formula W = P x w represent in GDP calculation?
a) The nominal wage
b) The real wage
c) The total income in an economy
d) The value added by firms
Answer: a) The nominal wage
14. How is real wage (w) calculated in terms of nominal wage (W) and price level (P)?
a) w = W / P
b) w = W x P
c) w = W + P
d) w = W - P
Answer: a) w = W / P
15. What is the purpose of comparing output in different years using base-year prices?
a) To estimate inflation rates
b) To adjust for changes in the quantity of goods and services
c) To measure real GDP
d) To calculate nominal GDP
Answer: b) To adjust for changes in the quantity of goods and services
16. How is real GDP in 2003 computed using base-year prices (2002)?
a) [2003 P (A) x 2003 Q (A)] + [2003 P (O) x 2003 Q (O)]
b) [2002 P (A) x 2003 Q (A)] + [2002 P (O) x 2003 Q (O)]
c) [2002 P (A) x 2002 Q (A)] + [2002 P (O) x 2002 Q (O)]
d) [2002 P (A) x 2004 Q (A)] + [2002 P (O) x 2004 Q (O)]
Answer: b) [2002 P (A) x 2003 Q (A)] + [2002 P (O) x 2003 Q (O)]
17. What is NOT included in Nominal GDP?
a) Changes in the price level
b) Changes in the quantity of goods and services
c) Changes in the real output
d) Changes in the money supply
Answer: b) Changes in the quantity of goods and services
18. How does the value of Real GDP differ from Nominal GDP?
a) Real GDP is measured in constant prices, while Nominal GDP is measured in current prices
b) Real GDP includes only final goods, while Nominal GDP includes both intermediate and final
goods
c) Real GDP is adjusted for inflation, while Nominal GDP is not adjusted
d) Real GDP is always higher than Nominal GDP

Answer: a) Real GDP is measured in constant prices, while Nominal GDP is measured in
current prices
19. What is the purpose of including imputed values in GDP calculation?
a) To reduce the overall GDP
b) To estimate the value of goods and services with no market prices
c) To exclude non-market activities from GDP
d) To increase the GDP artificially
Answer: b) To estimate the value of goods and services with no market prices
20. Why are used goods excluded from the calculation of GDP?
a) Used goods have no market value
b) Including used goods would result in double-counting
c) Used goods are considered of low value
d) Including used goods would overstate the GDP
Answer: b) Including used goods would result in double-counting
Q&A:
1. What is Gross Domestic Product (GDP), and how is it defined?
Answer: GDP is the total market value of all goods and services produced within the political
boundaries of an economy during a given period, usually one year.
2. Why GDP is considered the government's official measure of an economy's output?
Answer: GDP reflects the total output of an economy, including both the total expenditure on
domestically-produced final goods and services and the total income earned by domestically-
located factors of production.
3. Explain the concept of "Expenditure = Income" in the circular flow of income.
Answer: In every economic transaction, the buyer's expenditure becomes the seller's income.
Therefore, the sum of all expenditures equals the sum of all income in the economy.
4. How GDP is computed using market prices, and what is the formula for it?
Answer: GDP = [P (A) × Q (A)] + [P (O) × Q (O)], where P represents prices and Q represents
quantities of different goods and services.
5. Why are used goods excluded from the calculation of GDP?
Answer: Used goods are excluded to avoid double-counting. The value of final goods already
includes the value of intermediate goods, and including used goods would result in counting
them more than once.
6. Explain the concept of value added in the context of GDP computation.
Answer: Value added of a firm equals the value of the firm’s output less the value of the
intermediate goods the firm purchases.
7. In the given production process (farmer to engineer), how would you compute the value
added at each stage and the overall GDP?
Answer: Value added at each stage is the difference between the selling price and the cost of
intermediate goods. Overall GDP is the sum of value added at each stage.
8. Why are imputed values, such as home ownership and government services, included in
GDP?
Answer: Some goods and services do not have market prices, so their imputed values are used as
estimates to include them in GDP.
9. How does Nominal GDP differ from Real GDP, and why is this distinction important?
Answer: Nominal GDP is measured at current prices, while Real GDP is measured using a
constant set of prices. This distinction is important to separate changes in quantity from changes
in prices.
10. How is Real GDP calculated, and why is it considered a more accurate measure in some
contexts?
Answer: Real GDP is calculated as the value of goods and services using a constant set of
prices. It is considered more accurate because it adjusts for inflation.
11. Explain the conversion from nominal to real units, using wages as an example.
Answer: Nominal wages (W) can be decomposed into real wages (w) and the price variable (P),
where w = W/P.
12. How is real GDP computed in an economy with apples and oranges using base-year
prices?
Answer: Real GDP in a specific year is calculated as the sum of [base-year price × quantity] for
each good, where A stands for apples and O stands for oranges.
13. What does the formula Y = P × y represent in the context of nominal GDP?
Answer: Y represents nominal GDP, P represents the price level, and y represents real output. It
shows the relationship between nominal GDP, the price level, and real output.
14. Why are changes in the price level important in understanding nominal GDP
fluctuations over time?
Answer: Changes in the price level impact nominal GDP, as it measures the value of goods and
services at current prices. Therefore, changes in prices contribute to changes in nominal GDP.
15. How does the distinction between Nominal and Real GDP help in economic analysis?
Answer: The distinction helps separate changes in quantity from changes in prices, providing a
more accurate reflection of economic growth or contraction.
16. Why Real GDP is considered a more reliable indicator when comparing economic
performance across different years?
Answer: Real GDP adjusts for changes in the price level, allowing for a more accurate
comparison of economic performance over time.
17. Can you provide an example of an imputed value included in GDP, and explain why it
is included?
Answer: Home ownership is an imputed value included in GDP. It reflects the value of housing
services even though there is no market transaction, contributing to the overall estimation of
GDP.
18. How does the circular flow of income illustrate the relationship between expenditure
and income in an economy?
Answer: In every economic transaction, the expenditure of the buyer becomes the income of the
seller, forming a circular flow where expenditure equals income.
19. Why are government services, such as those provided by police officers and firefighters,
included in GDP?
Answer: Government services are included in GDP because they contribute to the overall
economic activity, and their value is estimated as part of imputed values.
20. Explain the purpose of using a constant set of prices in measuring Real GDP.
Answer: Using a constant set of prices in measuring Real GDP eliminates the impact of price
changes, providing a more accurate reflection of changes in the quantity of goods and services
produced over time.
Lesson 05
(CONTINUED)
MCQs:
1. How is Nominal GDP calculated?
a) Nominal GDP = Real GDP / Price level
b) Nominal GDP = Price level x Real GDP
c) Nominal GDP = Expenditure - Income
d) Nominal GDP = Value added
Answer: b) Nominal GDP = Price level x Real GDP
2. In the computation of Nominal GDP, what is the purpose of using a base year?
a) To estimate inflation rates
b) To adjust for changes in quantity
c) To measure real growth
d) To compare values over time using constant prices
Answer: d) To compare values over time using constant prices
3. What does the GDP Deflator measure?
a) The quantity of goods and services
b) The overall level of prices in the economy
c) Real GDP in constant prices

d) Nominal GDP in current prices
Answer: b) The overall level of prices in the economy
4. How is the GDP Deflator calculated?
a) Nominal GDP / Real GDP
b) Real GDP / Nominal GDP
c) Nominal GDP x 100 / Real GDP
d) Real GDP x 100 / Nominal GDP
Answer: c) Nominal GDP x 100 / Real GDP
5. What does the inflation rate represent in the context of the GDP Deflator?
a) The change in quantity of goods and services
b) The change in the overall level of prices
c) The change in real GDP
d) The change in nominal GDP
Answer: b) The change in the overall level of prices
6. Why might chain-weighted measures of GDP be considered more accurate in certain

cases?
a) They use base year prices that never change
b) They ensure that prices will not be too out of date
c) They rely on prices from the most recent year only
d) They ignore changes in prices over time
Answer: b) They ensure that prices will not be too out of date
7. What are the components of expenditures in the equation Y = C + I + G + NX?
a) Consumption, Investment, Goods, Net Exports
b) Capital, Income, Government Spending, Exports

c) Consumption, Investment, Government Spending, Net Exports
d) Capital, Income, Goods, Exports
Answer: c) Consumption, Investment, Government Spending, Net Exports
8. What does "Investment" refer to in the context of National Income Accounting?
a) Spending on goods and services by households
b) Spending on capital and goods bought for future use
c) Government purchases of goods and services
d) Net exports or net foreign demand
Answer: b) Spending on capital and goods bought for future use
9. What is the difference between Capital and Investment?
a) Capital is spending on new goods, while Investment is a factor of production
b) Capital is a stock, while Investment is a flow
c) Capital is measured at an instant in time, while Investment is measured over a period
d) Capital is included in GDP, while Investment is not
Answer: b) Capital is a stock, while Investment is a flow
10. How is the GDP Deflator related to Nominal GDP and Real GDP?
a) GDP Deflator = Nominal GDP x 100
b) GDP Deflator = Nominal GDP / Real GDP
c) GDP Deflator = Real GDP / Nominal GDP
d) GDP Deflator = Nominal GDP - Real GDP
Answer: b) GDP Deflator = Nominal GDP / Real GDP
11. What does Consumption (C) include in National Income Accounting?
a) Spending on durable goods only

b) Spending on non-durable goods only
c) Spending on services and goods by households
d) Spending on goods by businesses
Answer: c) Spending on services and goods by households
12. What is the purpose of including Net Exports (NX) in the expenditure equation?
a) To measure the overall level of prices
b) To account for changes in government spending
c) To reflect the difference between total exports and total imports
d) To calculate the inflation rate
Answer: c) To reflect the difference between total exports and total imports
13. Why is government spending on transfer payments excluded from the expenditure
equation?
a) Transfer payments are not considered spending on goods and services
b) Transfer payments are included in Net Exports
c) Government spending on transfer payments is negligible
d) Transfer payments are counted separately in GDP
Answer: a) Transfer payments are not considered spending on goods and services
14. What is the formula for Net Exports (NX)?
a) NX = Exports - Imports
b) NX = Exports + Imports
c) NX = Exports / Imports
d) NX = Imports - Exports
Answer: a) NX = Exports - Imports
15. How is unsold output accounted for in the expenditure = output identity?
a) It is excluded from the calculation of GDP
b) It is considered a reduction in real GDP
c) It is counted as "inventory investment"
d) It is added to government spending
Answer: c) It is counted as "inventory investment"
16. Why does the equation output = expenditure hold true in National Income Accounting?
a) Because firms always purchase their unsold output
b) Because output and expenditure are independent variables
c) Because firms are required to sell all their produced goods
d) Because unsold output is considered as "inventory investment"
Answer: d) Because unsold output is considered as "inventory investment"
17. What is the purpose of using a chain-weighted measure of GDP?
a) To ensure constant prices over time
b) To adjust for changes in the quantity of goods and services
c) To eliminate the need for a base year
d) To compare output between any two dates without outdated prices
Answer: d) To compare output between any two dates without outdated prices
18. What is included in the category of "Stocks" in economic measurement?
a) Population, employment, capital, business inventories
b) Savings, number of new college graduates, government budget deficit
c) Wealth, number of people with college degrees, government debt
d) Nominal GDP, Real GDP, GDP Deflator
Answer: a) Population, employment, capital, business inventories

19. Which of the following is an example of a "Flow" in economic measurement?
a) GDP, capital, wealth
b) Savings, government debt, business inventories
c) Population, employment, number of new college graduates
d) Nominal GDP, Real GDP, GDP Deflator
Answer: b) Savings, government debt, business inventories
20. What is the purpose of including Net Exports (NX) in the expenditure equation?
a) To measure the overall level of prices
b) To account for changes in government spending
c) To reflect the difference between total exports and total imports
d) To calculate the inflation rate
Answer: c) To reflect the difference between total exports and total imports
Q&A:
1. What is the purpose of computing nominal and real GDP?
 Answer: The purpose is to measure the total market value of goods and services produced
and to account for changes in prices over time.
2. Explain the calculation of Nominal GDP in the given example for the year 2001.
 Answer: Nominal GDP (2001) = (Price of Good A * Quantity of Good A) + (Price of

Good B * Quantity of Good B) = (30 * 900) + (100 * 192) = Rs46,200
3. How Real GDP is calculated using the base year (2001) in the example?
 Answer: Real GDP (2001) = (Price of Good A in 2001 * Quantity of Good A in 2001) +
(Price of Good B in 2001 * Quantity of Good B in 2001) = Rs46,300
4. Define the GDP deflator and its role in measuring the overall level of prices.
 Answer: The GDP deflator measures the price of output relative to its price in the base
year. It reflects changes in the overall level of prices in the economy.
5. Calculate the inflation rate using the GDP deflator for the year 2002 in the given
example.
 Answer: Inflation Rate (2002) = ((GDP Deflator in 2002 - GDP Deflator in 2001) / GDP
Deflator in 2001) * 100 = ((102.8 - 100) / 100) * 100 = 2.8%
6. Why might chain-weighted measures of GDP be considered more accurate than

traditional measures?
 Answer: Chain-weighted measures are considered more accurate because they use
average prices over consecutive years, avoiding the outdated base year problem.
7. List the components of expenditures in the equation Y = C + I + G + NX.
 Answer: Y (Total Demand) = C (Consumption) + I (Investment) + G (Government

Spending) + NX (Net Exports)
8. What does "Investment" represent in National Income Accounting?
 Answer: Investment represents spending on the factor of production (capital) and goods
bought for future use.
9. Explain the difference between Capital and Investment.
 Answer: Capital is the overall stock of factors of production, while Investment is the
spending on new capital.
10. Why is government spending on transfer payments excluded from the expenditure
equation? - Answer: Transfer payments are excluded because they do not represent spending on
goods and services.
11. Define Net Exports (NX) and its role in the expenditure equation. - Answer: Net Exports
(NX) = Exports - Imports. It reflects the difference between total exports and total imports in the
expenditure equation.
12. What is the purpose of using a chain-weighted measure of GDP? - Answer: The chain-
weighted measure ensures that prices are not too out of date and allows for a more accurate
comparison of output between any two dates.
13. Explain the concept of "Stocks" in economic measurement. - Answer: Stocks are
variables defined for an instant in time, such as population, employment, capital, and business
inventories.
14. Provide an example of a "Flow" in economic measurement. - Answer: GDP is an

example of a flow, representing the flow of production during a given year.
15. How is unsold output accounted for in the expenditure = output identity? - Answer:
Unsold output is counted as "inventory investment" in the expenditure = output identity.
16. Why does the equation output = expenditure hold true in National Income Accounting?
- Answer: The equation holds true because unsold output is considered as "inventory
investment," assuming firms purchase their unsold output.
17. Explain the purpose of including Net Exports (NX) in the expenditure equation. -
Answer: Including Net Exports accounts for the difference between total exports and total
imports, reflecting the net foreign demand.
18. How does Chain-Weighted Measures of GDP address the issue of outdated prices? -
Answer: Chain-weighted measures use average prices over consecutive years, ensuring that
prices are not too out of date.
19. What is the relationship between GDP Deflator, Nominal GDP, and Real GDP? -
Answer: GDP Deflator = (Nominal GDP / Real GDP) * 100. It measures the price of output
relative to its price in the base year.
20. Explain the concept of "Flow" in economic measurement with an example. - Answer: A
flow is a variable defined for a period of time. Example: GDP, which represents the flow of
production during a given year.
Lesson 06

(CONTINUED)
MCQs:
1. What does Gross National Product (GNP) measure?
a) Total market value of goods and services produced within an economy
b) Total market value of goods and services produced by the citizens of an economy
c) Total market value of goods and services produced globally
d) Total market value of imports and exports
Answer: b) Total market value of goods and services produced by the citizens of an economy
2. How is GNP different from GDP?

a) GNP includes foreign remittances, while GDP does not
b) GNP measures only goods production, while GDP includes services
c) GDP includes foreign remittances, while GNP does not
d) GNP measures only domestic production, while GDP includes global production
Answer: a) GNP includes foreign remittances, while GDP does not
3. What does the formula (GNP–GDP) = (Factor payments from abroad) minus (Factor
payments to abroad) represent?
a) Net Exports
b) Depreciation
c) Unemployment rate
d) Inflation rate
Answer: a) Net Exports
4. How is Net National Product (NNP) calculated?
a) NNP = GNP + Depreciation
b) NNP = GNP - Depreciation
c) NNP = GDP + Depreciation
d) NNP = GDP - Depreciation
Answer: b) NNP = GNP - Depreciation
5. What does National Income (NI) represent?
a) NI = NNP + Indirect Business Taxes
b) NI = NNP - Indirect Business Taxes
c) NI = NNP - Corporate Profits
d) NI = NNP + Corporate Profits
Answer: b) NI = NNP - Indirect Business Taxes

6. Which measure accounts for personal income after taxes?
a) Net National Product (NNP)
b) National Income (NI)
c) Personal Income (PI)
d) Disposable Personal Income (DPI)
Answer: d) Disposable Personal Income (DPI)
7. What is the purpose of the Consumer Price Index (CPI)?
a) Measure the overall level of prices
b) Track changes in the typical household’s cost of living
c) Adjust contracts for inflation
d) All of the above
Answer: d) All of the above
8. How is the CPI calculated?
a) CPI = Cost of basket in the current month / Cost of basket in the base period
b) CPI = Cost of basket in the base period / Cost of basket in the current month
c) CPI = Cost of basket in the current month × 100 / Cost of basket in the base period
d) CPI = Cost of basket in the base period × 100 / Cost of basket in the current month
Answer: c) CPI = Cost of basket in the current month × 100 / Cost of basket in the base
period
9. In which measure are the weights fixed over time?
a) CPI
b) GDP Deflator
c) Both CPI and GDP Deflator
d) Neither CPI nor GDP Deflator

Answer: c) Both CPI and GDP Deflator
10. Why might the CPI overstate inflation?
a) Substitution bias
b) Introduction of new goods
c) Unmeasured changes in quality
d) All of the above
Answer: d) All of the above
11. What does the GDP Deflator include that the CPI excludes?
a) Prices of capital goods
b) Prices of imported consumer goods
c) Both a and b
d) None of the above
Answer: c) Both a and b
12. What is the unemployment rate?
a) The percentage of the adult population that participates in the labor force
b) The percentage of the labor force that is unemployed
c) The percentage of the adult population that is unemployed
d) The percentage change in real GDP
Answer: b) The percentage of the labor force that is unemployed
13. What does Okun's Law suggest about the relationship between unemployment and real
GDP?
a) There is a positive relationship
b) There is a negative relationship
c) There is no relationship
d) The relationship is constant over time
Answer: b) There is a negative relationship
14. If the labor force increases by 3%, and the number of unemployed persons increases by
2%, what is the change in the unemployment rate?
a) +1%
b) -1%
c) +5%
d) -5%
Answer: a) +1%
15. How is Disposable Personal Income (DPI) calculated?
a) DPI = PI - Tax
b) DPI = PI + Tax
c) DPI = PI / Tax
d) DPI = PI × Tax
Answer: a) DPI = PI - Tax
16. Which measure accounts for personal interest income?
a) Net National Product (NNP)
b) National Income (NI)
c) Personal Income (PI)
d) Disposable Personal Income (DPI)
Answer: c) Personal Income (PI)
17. In Pakistan, which measure would you want to be bigger—GDP or GNP? Why?
a) GDP, because it includes foreign remittances
b) GNP, because it includes foreign remittances

c) Either GDP or GNP, as they are interchangeable
d) Neither GDP nor GNP, as they have no significance
Answer: b) GNP, because it includes foreign remittances
18. What is the labor force participation rate?
a) The percentage of the adult population that participates in the labor force
b) The percentage of the labor force that is unemployed
c) The percentage of the adult population that is unemployed
d) The percentage change in real GDP
Answer: a) The percentage of the adult population that participates in the labor force
19. What does the formula (GNP–GDP) = (Factor payments from abroad) minus (Factor
payments to abroad) represent?
a) Net Exports
b) Depreciation
c) Unemployment rate
d) Inflation rate
Answer: a) Net Exports
20. What does Okun's Law suggest about the relationship between unemployment and real
GDP?
a) There is a positive relationship
b) There is a negative relationship
c) There is no relationship
d) The relationship is constant over time
Answer: b) There is a negative relationship
Q&A:
1. What is Gross National Product (GNP)?
 A: GNP is the total market value of all goods and services produced by the citizens of an
economy during a given period, usually one year.
2. How does GNP differ from Gross Domestic Product (GDP)?
 A: GNP includes foreign remittances, while GDP measures the total market value of
goods and services produced within the political boundaries of an economy.
3. What does the formula (GNP–GDP) represent?
 A: (GNP–GDP) represents the difference between factor payments from abroad and
factor payments to abroad.
4. What is Net National Product (NNP)?
 A: NNP is GNP adjusted for depreciation; NNP = GNP – Depreciation.
5. Define National Income (NI).
 A: NI is equal to NNP minus indirect business taxes.
6. How is Disposable Personal Income (DPI) calculated?
 A: DPI is calculated as Personal Income (PI) minus taxes.
7. What is the Consumer Price Index (CPI) used for?
 A: The CPI is used to track changes in the typical household’s cost of living, adjust
contracts for inflation, and allow comparisons of dollar figures from different years.
8. How is the CPI calculated?
 A: The CPI in any month equals the cost of the basket in that month divided by the cost
of the basket in the base period, multiplied by 100.
9. In constructing the CPI, what does the "basket" of goods represent?
 A: The "basket" of goods represents the composition of the typical consumer’s purchases.
 A: The CPI may overstate inflation due to substitution bias, introduction of new goods,
and unmeasured changes in quality.
11. How does the CPI differ from the GDP deflator in terms of the basket of goods?
 A: The CPI has a fixed basket of goods, while the GDP deflator changes every year.
12. What is the unemployment rate?
 A: The unemployment rate is the percentage of the labor force that is unemployed,
calculated as the number of unemployed individuals divided by the labor force,
multiplied by 100.
13. Define the labor force participation rate.
 A: The labor force participation rate is the fraction of the adult population that
participates in the labor force, calculated as the labor force divided by the adult
population, multiplied by 100.
14. According to Okun’s Law, what is the relationship between unemployment and real
GDP?
 A: Okun’s Law suggests a negative relationship between unemployment and real GDP. A
decrease in unemployment is associated with additional growth in real GDP.
15. What does a negative change in the unemployment rate imply according to Okun’s
Law?
 A: A negative change in the unemployment rate implies an increase in real GDP.
16. How is the GDP Deflator different from the CPI in terms of goods included?
 A: The GDP Deflator includes prices of capital goods, while the CPI excludes them.
17. Define the categories of the population in labor force concepts.
 A: The categories include employed, unemployed, labor force, and not in the labor force.
18. How is the GDP Deflator different from the CPI in terms of the basket of goods?
 A: The GDP Deflator has a changing basket of goods, while the CPI has a fixed basket.
19. What does the formula (GNP–GDP) represent?
 A: (GNP–GDP) represents the net exports, calculated as factor payments from abroad
minus factor payments to abroad.

 A: The CPI may overstate inflation due to substitution bias, introduction of new goods,
and unmeasured changes in quality.
Lesson 07
CLOSED ECONOMY, MARKET CLEARING
MODEL
MCQs:
1. What is the focus of the closed economy, market-clearing model described in Lesson
07?
a. International trade
b. Factor markets
c. Technology advancements
d. Government interventions
Answer: b. Factor markets
2. Which side of the model includes determinants of consumption (C), investment (I),
and government spending (G)?
a. Supply side
b. Demand side
c. Equilibrium side
d. Financial markets side
Answer: b. Demand side
3. In the production function Y = F(K, L), what does 'Y' represent?
a. Real rental rate

b. Nominal wage
c. Total output
d. Government purchases
Answer: c. Total output
4. What are the assumptions about technology in the model?
a. Technology is variable
b. Technology is fixed
c. Technology is government-controlled
d. Technology is unpredictable
Answer: b. Technology is fixed
5. Which markets contribute to the equilibrium in the goods market?
a. Markets for goods and services

b. Financial markets
c. Markets for factors of production
d. All of the above
Answer: a. Markets for goods and services
6. What are the factors of production in the model?
a. K = Capital, L = Labor
b. C = Consumption, I = Investment
c. Y = Output, F = Function
d. P = Price, R = Rental rate
Answer: a. K = Capital, L = Labor
7. How is national income distributed in the model?
a. By government decisions
b. By factor prices
c. By international trade
d. By technology advancements
Answer: b. By factor prices
8. What does the production function Y = F(K, L) exhibit?
a. Increasing returns to scale

b. Decreasing returns to scale
c. Constant returns to scale
d. Variable returns to scale
Answer: c. Constant returns to scale
9. How are factor prices determined in the model?
a. By government regulations
b. By international agreements
c. By supply and demand in factor markets
d. By technology advancements
Answer: c. By supply and demand in factor markets
10. What does the real wage (W/P) represent in the model?
a. Nominal wage
b. Price of output
c. Wage measured in units of output
d. Real rental rate
Answer: c. Wage measured in units of output
11. What is the basic idea behind the firm's decision to hire labor in a competitive
market?
a. Benefit should exceed cost

b. Cost should exceed benefit
c. Benefit and cost are irrelevant
d. Government determines hiring decisions
Answer: a. Benefit should exceed cost
12. What does MPL stand for in the context of the model?
a. Market Price Level

b. Marginal Product of Labor
c. Model Production Limit
d. Macroeconomic Price Level
Answer: b. Marginal Product of Labor
13. What does MPL represent in the production function graph?
a. Output
b. Labor
c. Units of output (MPL)
d. Nominal wage
Answer: c. Units of output (MPL)
14. As more labor is added, what happens to MPL according to the production
function?
a. MPL increases
b. MPL decreases
c. MPL remains constant
d. MPL becomes unpredictable
Answer: b. MPL decreases
15. What is the relationship between the slope of the production function and MPL?
a. The slope equals MPL

b. The slope is unrelated to MPL
c. The slope is opposite to MPL
d. The slope is constant
Answer: a. The slope equals MPL
16. What does the real rental rate (R/P) represent in the model?
a. Nominal rental rate
b. Price of output
c. Rental rate measured in units of output
d. Wage measured in units of output
Answer: c. Rental rate measured in units of output
17. What is the role of financial markets in the model?
a. Determine factor prices

b. Achieve equilibrium in the goods market
c. Distribute national income
d. Determine government purchases
Answer: b. Achieve equilibrium in the goods market
18. How is output determined in the model?
a. By government decisions
b. By factor supplies and technology
c. By international trade
d. By financial market conditions
Answer: b. By factor supplies and technology
19. What is the significance of the equilibrium in the goods market?
a. It determines factor prices

b. It ensures total output equals total demand
c. It determines government deficit
d. It affects international trade
Answer: b. It ensures total output equals total demand
20. In the context of the model, what does 'equilibrium' mean?
a. A state of balance in the financial markets

b. A state where factor prices are unpredictable
c. A state where total output equals total demand
d. A state determined by government interventions
Answer: c. A state where total output equals total demand
Q&A:
1. What is the central question addressed in Lesson 07's closed economy model?
o Answer: The determinants of the economy's total output/income.
2. Explain the role of the supply side in the closed economy model.
o Answer: The supply side includes factor markets (supply, demand, price) and
determines output/income.
3. Define the production function in the closed economy model.
o Answer: Y = F(K, L), representing the economy's output produced from capital
(K) and labor (L).
4. What are the assumptions regarding technology in this model?
o Answer: Technology is assumed to be fixed.
5. How is GDP determined in the closed economy model?
o Answer: GDP is determined by fixed factor supplies and the fixed state of
technology: Y = F(K, L).
6. What are the factors of production in the model, and how are they denoted?
o Answer: Factors are K (capital) and L (labor).
7. What determines the distribution of national income in the model?
o Answer: Factor prices, where wages and rental rates are crucial.
8. Explain the concept of the real wage in the closed economy model.
o Answer: W/P, representing the wage measured in units of output.
9. How are factor prices determined in the closed economy model?
o Answer: Factor prices are determined by supply and demand in factor markets.
10. What is the basic idea behind a firm's decision to hire labor in competitive markets?
o Answer: A firm hires each unit of labor if the cost (real wage) does not exceed the
benefit (marginal product of labor).
11. Define and explain the marginal product of labor (MPL).
o Answer: MPL is the extra output a firm can produce using an additional unit of
labor, represented as MPL = F(K, L + 1) – F(K, L).
12. How does MPL change as more labor is added in the production function?
o Answer: MPL decreases as more labor is added.
13. What does the slope of the production function equal in relation to MPL?
o Answer: The slope equals MPL.
14. What markets contribute to achieving equilibrium in the closed economy model?
o Answer: Goods market and loanable funds market.
15. What is the significance of equilibrium in the goods market?
o Answer: It ensures total output equals total demand.
16. Explain the role of financial markets in achieving equilibrium.
o Answer: Financial markets contribute to achieving equilibrium in the goods
market.
17. How is total income distributed in the closed economy model?
o Answer: The distribution is determined by factor prices, such as wages and rental
rates.
18. What are the key determinants of demand for goods and services in the model?
o Answer: Factors such as consumption (C), investment (I), and government
spending (G).
19. In the context of the closed economy model, what does 'equilibrium' mean?
o Answer: A state where total output equals total demand.
20. What does the closed economy model assume about the supplies of capital and
labor?
o Answer: Supplies of capital (K) and labor (L) are fixed in the model.
Lesson 08
CLOSED ECONOMY, MARKET CLEARING
MODEL (CONTINUED)
MCQs:
1. What does the concept of diminishing marginal returns imply?
a. Marginal product increases with additional input.
b. Marginal product remains constant with additional input.
c. Marginal product falls as the factor input increases.
d. Marginal product is unpredictable.
Answer: c. Marginal product falls as the factor input increases.
2. What happens to productivity when labor is increased while holding capital fixed?
a. Productivity remains constant.
b. Productivity increases.
c. Productivity decreases.
d. Productivity becomes unpredictable.
Answer: c. Productivity decreases.
3. What is the relationship between MPL (Marginal Product of Labor) and the
demand for labor?
a. Inverse relationship
b. Direct relationship
c. Unrelated
d. Dynamic relationship
Answer: b. Direct relationship
4. How is the rental rate (R/P) determined in the market-clearing model?

a. MPK = R/P
b. MPL = R/P
c. MPK = W/P
d. MPL = W/P
Answer: a. MPK = R/P
5. What does the MPK curve represent for a firm in the market-clearing model?
a. Supply curve for capital
b. Demand curve for labor
c. Demand curve for capital
d. Supply curve for labor
Answer: c. Demand curve for capital
6. How do firms maximize profits in the neoclassical theory of distribution?
a. By increasing labor input
b. By choosing K such that MPL = R/P
c. By choosing L such that MPK = W/P
d. By ignoring marginal product
Answer: b. By choosing K such that MPL = R/P
7. What does the neoclassical theory of distribution state regarding factor inputs?
a. Each factor input is paid its average product.
b. Each factor input is paid its marginal product.
c. Factor inputs are paid a fixed wage.
d. Factor inputs are paid based on seniority.
Answer: b. Each factor input is paid its marginal product.

8. How is total labor income calculated in the neoclassical theory of distribution?
a. W/P x L
b. MPL x L
c. R/P x K
d. MPK x K
Answer: a. W/P x L
9. What does the neoclassical theory assume about the payment of factor inputs?
a. Factors are paid their average product.
b. Factors are paid based on seniority.
c. Factors are paid their marginal product.
d. Factors are paid a fixed wage.
Answer: c. Factors are paid their marginal product.
10. If a production function has constant returns to scale, what is the relationship
between Y, MPL, and MPK?
a. Y = MPL + MPK
b. Y = MPL - MPK
c. Y = MPL x L + MPK x K
d. Y = MPL / MPK
Answer: c. Y = MPL x L + MPK x K
11. In the neoclassical theory, what is the relationship between MPK and the rental rate
as capital increases?
a. MPK increases
b. MPK decreases
c. MPK remains constant

d. MPK becomes unpredictable
Answer: b. MPK decreases
12. What is the logic behind the firm's demand curve for renting capital in the market-
clearing model?
a. MPK = R/P
b. MPK = W/P
c. MPK = MPL
d. MPK = Y
Answer: a. MPK = R/P
13. How is total capital income calculated in the neoclassical theory of distribution?
a. R/P x K
b. MPK x K
c. W/P x L
d. MPL x L
Answer: b. MPK x K
14. What happens to MPL as additional units of labor are added, holding other inputs
constant?
a. MPL increases
b. MPL decreases
c. MPL remains constant
d. MPL becomes unpredictable
Answer: b. MPL decreases
15. What does the slope of the MPK curve represent?
a. Rental rate
b. Marginal product of labor
c. Change in output per additional unit of capital
d. Change in output per additional unit of labor
Answer: c. Change in output per additional unit of capital
16. What is the significance of the MPK curve for a firm in the market-clearing model?
a. It determines the demand for labor.
b. It represents the supply curve for capital.
c. It guides the firm's capital hiring decision.
d. It is unrelated to production decisions.
Answer: c. It guides the firm's capital hiring decision.
17. In the neoclassical theory, what is the basis for distributing total labor income?
a. Average product of labor
c. Fixed wage rate
d. Seniority
Answer: b. Marginal product of labor
18. How is the demand for labor determined by firms in the neoclassical model?
a. By choosing L such that MPK = W/P
b. By choosing K such that MPK = R/P
c. By ignoring the marginal product
d. By following a fixed wage rate
Answer: a. By choosing L such that MPK = W/P
19. What does the constant return to scale in a production function imply?
a. Output increases proportionally with input increases.
b. Output decreases proportionally with input increases.
c. Output remains constant with input increases.
d. Output becomes unpredictable with input increases.
Answer: a. Output increases proportionally with input increases.
20. According to the neoclassical theory, what is the ultimate goal of firms in the
market-clearing model?
a. Maximize labor income
b. Maximize capital income
c. Maximize profits
d. Maximize wages
Answer: c. Maximize profits
Q&A:
1. Explain the concept of diminishing marginal returns.
o Answer: Diminishing marginal returns imply that as a factor input is increased, its
marginal product falls, assuming other factors are constant.
2. What happens to productivity when labor is increased while holding capital fixed?
o Answer: Productivity decreases because there are fewer machines per worker.
3. How is the demand for labor related to the marginal product of labor (MPL)?
o Answer: There is a direct relationship; as MPL increases, the demand for labor
also increases.
4. How is the rental rate (R/P) determined in the market-clearing model?
o Answer: The rental rate is determined by the diminishing returns to capital, where
MPK (Marginal Product of Capital) decreases as capital increases.
5. What is the significance of the MPK curve in the market-clearing model?
o Answer: The MPK curve represents the firm's demand curve for renting capital
and guides the firm in maximizing profits.
6. According to the neoclassical theory of distribution, how do firms maximize profits?
o Answer: Firms maximize profits by choosing the amount of capital (K) such that
MPK = R/P.
7. What is the fundamental principle of the neoclassical theory of distribution?
o Answer: Each factor input is paid its marginal product.
8. How is total labor income calculated in the neoclassical theory of distribution?
o Answer: Total labor income is calculated as W/P multiplied by the quantity of
labor (L), which equals MPL multiplied by L.
9. Similarly, how is total capital income calculated in the neoclassical theory?
o Answer: Total capital income is calculated as R/P multiplied by the quantity of
capital (K), which equals MPK multiplied by K.
10. What does the constant return to scale in a production function imply?
o Answer: If a production function has constant returns to scale, it implies that total
output (Y) is the sum of MPL multiplied by L and MPK multiplied by K.
11. How does the neoclassical theory explain the distribution of income between labor
and capital?
o Answer: Total labor income is determined by the marginal product of labor
(MPL), and total capital income is determined by the marginal product of capital
(MPK).
12. What is the economic intuition behind diminishing marginal returns to capital?
o Answer: As capital (K) increases, its marginal product (MPK) falls, reflecting the
idea that adding more capital becomes less productive.
13. In the context of determining the rental rate, what is the logic behind firms choosing
K such that MPK = R/P?
o Answer: Firms choose the amount of capital (K) to rent so that the marginal
product of capital (MPK) equals the rental rate (R/P), maximizing profits.
14. What is the assumption about factor payments in the neoclassical theory of
distribution?
o Answer: Factor payments are assumed to be based on the marginal product of the
respective factor input.
15. How does the neoclassical theory justify the payment of factor inputs?
o Answer: Factors are paid according to their marginal product, reflecting their
contribution to the production process.
16. If a firm seeks to maximize profits, what condition should it satisfy in choosing the
amount of capital (K)?
o Answer: The firm should choose K such that MPK equals the rental rate (MPK =
R/P).
17. What is the role of the MPK curve in the decision-making process of a firm in the
market-clearing model?
o Answer: The MPK curve serves as the firm’s demand curve for renting capital,
guiding decisions on the optimal amount of capital to maximize profits.
18. What does the neoclassical theory propose about the relationship between factor
payment and marginal product?
o Answer: The theory proposes that each factor input is paid its marginal product.
19. In the neoclassical theory, what is the basis for distributing total labor income?
o Answer: Total labor income is distributed based on the marginal product of labor
(MPL).
20. If a production function has constant returns to scale, how can the total output (Y)
be expressed?
o Answer: Y = MPL multiplied by L plus MPK multiplied by K, assuming constant
returns to scale.
Lesson 09
COMPONENTS OF AGGREGATE DEMAND

MCQs:
1. What does the consumption function (C = C(Y - T)) in a closed economy indicate?
a. Consumer demand for goods and services
b. Demand for investment goods
c. Government demand for goods and services
d. Net exports
Answer: a. Consumer demand for goods and services
2. What is the Keynesian Consumption function, and how does it respond to an

increase in disposable income?
a. C = C(Y - T), and an increase in (Y - T) leads to a decrease in C.
b. C = C(Y - T), and an increase in (Y - T) leads to an increase in C.
c. C = C(Y - T), and (Y - T) has no impact on C.
d. C = C(Y - T), and the relationship is unpredictable.
Answer: b. C = C(Y - T), and an increase in (Y - T) leads to an increase in C.
3. What is the Marginal Propensity to Consume (MPC) in the Keynesian Consumption

function?
a. The increase in C caused by a one-unit increase in Y.
b. The increase in C caused by a one-unit decrease in Y.
c. The decrease in C caused by a one-unit increase in Y.
d. The decrease in C caused by a one-unit decrease in Y.
Answer: a. The increase in C caused by a one-unit increase in Y.

4. What does the investment function (I = I(r)) depend on, and how does it respond to
an increase in the real interest rate (r)?
a. Investment depends on Y, and an increase in r leads to an increase in I.
b. Investment depends on r, and an increase in r leads to a decrease in I.
c. Investment depends on G, and an increase in r leads to an increase in I.
d. Investment depends on T, and an increase in r leads to a decrease in I.
Answer: b. Investment depends on r, and an increase in r leads to a decrease in I.
5. In the context of aggregate demand, what does the abbreviation "G" represent?
a. Gross investment
b. Government demand for goods and services
c. Global demand for goods
d. Gross domestic product (GDP)
Answer: b. Government demand for goods and services
6. What is the role of the real interest rate in the investment function?
a. It represents the cost of borrowing for households.
b. It represents the cost of borrowing for firms.
c. It is unrelated to investment decisions.
d. It is the nominal interest rate corrected for inflation.
Answer: b. It represents the cost of borrowing for firms.
7. In the loanable funds market, what does the supply of funds come from?
a. Government spending
b. Investment
c. Saving
d. Net exports
Answer: c. Saving
8. What is the relationship between the demand for loanable funds and the real
interest rate?
a. Positive relationship
b. Negative relationship
c. No relationship
d. Unpredictable relationship
Answer: b. Negative relationship
9. What is the definition of private saving in the context of the loanable funds model?
a. S = Y - C - G
b. S = T - G
c. S = (Y - T) - C
d. S = Y - C
Answer: c. S = (Y - T) - C
10. According to the neoclassical theory, what is the basis for distributing total labor
income?
a. Average product of labor
c. Fixed wage rate
d. Seniority
Answer: b. Marginal product of labor
11. What is the impact of an increase in the real interest rate on investment in the
loanable funds market?
a. Increase in investment
b. Decrease in investment
c. No impact on investment
d. Unpredictable impact on investment
Answer: b. Decrease in investment
12. In the loanable funds market, what does the supply curve represent?
a. Demand for loanable funds
b. Investment
c. Saving
d. The real interest rate
Answer: c. Saving
13. What is the special role of the real interest rate (r) in the loanable funds market?
a. It adjusts to equilibrate the goods market.
b. It has no impact on investment decisions.
c. It adjusts to equilibrate the goods market and the loanable funds market
simultaneously.
d. It is determined by government spending.
Answer: c. It adjusts to equilibrate the goods market and the loanable funds market
simultaneously.
14. What does the loanable funds market equilibrium imply?
a. S = Y - C - G
b. Y = C + I + G
c. S = I
d. Y = I + G
Answer: c. S = I
15. What is the role of the real interest rate in the demand for loanable funds?
a. It represents the opportunity cost of using one's own funds.
b. It has no impact on the demand for loanable funds.
c. It is the cost of borrowing.
d. It is determined by government spending.
Answer: c. It is the cost of borrowing.
16. What happens to the loanable funds market when public saving (T - G) increases?
a. The supply of funds increases.
b. The demand for funds increases.
c. The interest rate increases.
d. The interest rate decreases.
Answer: a. The supply of funds increases.
17. In the context of the loanable funds market, what is the impact of a budget deficit
(G - T)?
a. The supply of funds increases.
b. The demand for funds increases.
c. Public saving increases.
d. The supply of funds decreases.
Answer: b. The demand for funds increases.
18. What does the vertical supply curve in the loanable funds market signify?
a. Saving depends on the real interest rate.
b. Saving is independent of the real interest rate.
c. Investment depends on the real interest rate.
d. Investment is independent of the real interest rate.
Answer: b. Saving is independent of the real interest rate.

19. In the loanable funds market equilibrium, what does the equality S = I imply?
a. The interest rate is zero.
b. The goods market is in equilibrium.
c. Saving equals investment.
d. Government spending equals taxes.
Answer: c. Saving equals investment.
20. What is the significance of the loanable funds model in economic analysis?
a. It explains the distribution of income.
b. It helps analyze the equilibrium in the goods market.
c. It provides insights into the determination of the real interest rate.
d. It is unrelated to macroeconomic phenomena.
Answer: c. It provides insights into the determination of the real interest rate.
Q&A:
1. What are the components of aggregate demand in a closed economy?
A: Consumer demand for goods and services (C), demand for investment goods (I), and
government demand for goods and services (G).
2. Define disposable income in the context of consumption.
A: Disposable income is total income minus total taxes, represented as (Y - T).
3. Explain the Keynesian Consumption function and its relationship to disposable

income.
A: The Keynesian Consumption function is C = C(Y - T), indicating that an increase in

(Y - T) leads to an increase in consumption (C).
4. What is the Marginal Propensity to Consume (MPC) in the consumption function?
A: The MPC is the increase in consumption caused by a one-unit increase in disposable

income.
5. Describe the investment function and its dependence on the real interest rate (r).
A: The investment function is I = I(r), where an increase in the real interest rate (r) leads
to a decrease in investment (I).
6. What does government spending (G) include, and what does it exclude?
A: G includes government spending on goods and services but excludes transfer

payments.
7. Summarize the equation for aggregate demand in a closed economy.
A: Aggregate Demand (AD) = C(Y - T) + I(r) + G.
8. What is the slope of the consumption function, and what does it represent?
A: The slope is the Marginal Propensity to Consume (MPC), representing the increase in
consumption for a one-unit increase in disposable income.
9. Explain the loanable funds market as a supply-demand model of the financial

system.
A: It is a model with one asset (loanable funds) where investment demand meets saving
supply, and the real interest rate acts as the price.
10. What determines the demand for loanable funds in the market?
A: The demand for loanable funds comes from investment, and it depends negatively on
the real interest rate (r).
11. What contributes to the supply of loanable funds in the market?
A: The supply of loanable funds comes from saving by households and, potentially, the
government if it does not spend all tax revenue.
12. Define private saving in the context of the loanable funds model.
A: Private saving is calculated as (Y – T) – C, representing the part of income not

consumed.
13. Explain the types of saving and their relationship in national saving (S).
A: Private saving = (Y – T) – C, Public saving = T – G, and National saving (S) = Private

saving + Public saving = Y – C – G.
14. What is the significance of budget surpluses and deficits in the context of saving?
A: Surpluses occur when T > G, contributing to public saving. Deficits occur when T <
G, leading to negative public saving.
15. Describe the loanable funds supply curve and its dependence on the real interest
rate.
A: The supply curve is vertical, indicating that national saving does not depend on the
real interest rate.
16. In the loanable funds market, what happens when public saving (T - G) increases?
A: The supply of funds increases.
17. What is the impact of a budget deficit (G - T) on the demand for loanable funds?
A: The demand for funds increases.
18. Explain the equilibrium in the loanable funds market.
A: The real interest rate adjusts to equilibrate the goods market and the loanable funds
market simultaneously, ensuring S = I.
19. What is the role of the real interest rate in equating demand and supply in the
A: The real interest rate adjusts to ensure that S = I, contributing to equilibrium in both
the goods market and the loanable funds market.
20. What insights does the loanable funds model provide in economic analysis?
A: The model helps analyze the determination of the real interest rate, demonstrating the
interplay between saving and investment in the economy.
Lesson 10
THE ROLE OF GOVERNMENT & MONEY AND
INFLATION
MCQs:
1. According to the model, how does an increase in government spending (G > 0)
affect national saving (S)?
a. Increases S
b. Decreases S
c. No effect on S
d. Uncertain effect on S
Answer: b. Decreases S
2. What happens to consumption (C) when there is a decrease in total taxes (T < 0)?
a. C increases
b. C decreases
c. C remains unchanged
d. Uncertain effect on C
Answer: a. C increases
3. In the loanable funds model, what is the impact of an increase in desired investment
on the interest rate (r)?
a. r rises
b. r falls
c. r remains unchanged
d. Uncertain effect on r
Answer: a. r rises
4. How does a rise in investment demand affect the equilibrium level of investment (I)?
a. I increases
b. I decreases
c. I remains unchanged
d. Uncertain effect on I
Answer: c. I remains unchanged
5. According to the Classical Theory of Inflation, when do prices and markets clear?
a. In the short run
b. In the long run
c. Both short run and long run
d. Prices never clear
Answer: b. In the long run
6. What is inflation defined as in economics?
a. Decrease in the general level of prices
b. Increase in the money supply
c. Increase in the average level of prices over time
d. Increase in real value of money
Answer: c. Increase in the average level of prices over time
7. What is the basic measure of price inflation?
a. Consumer Price Index (CPI)
b. Producer Price Index (PPI)
c. Inflation Rate
d. Money Supply Index
Answer: c. Inflation Rate
8. Which of the following is an example of fiat money?
a. Gold coins
b. Silver bars
c. Paper currency
d. Diamond currency
Answer: c. Paper currency

9. What function of money refers to its ability to be readily used for transactions?
a. Medium of exchange
b. Unit of account
c. Store of value
d. Liquidity
Answer: a. Medium of exchange
10. What is liquidity in the context of money?
a. Ease of converting money into other assets
b. Money's intrinsic value
c. Money's purchasing power
d. Total money supply
Answer: a. Ease of converting money into other assets
11. Who conducts monetary policy in a country?
a. Government
b. Central Bank
c. Commercial Banks
d. Parliament
Answer: b. Central Bank
12. What is the State Bank of Pakistan (SBP) responsible for in monetary policy?
a. Controlling fiscal policy
b. Controlling money supply
c. Conducting foreign exchange markets
d. Regulating commercial banks

Answer: b. Controlling money supply
13. How does the State Bank conduct open market operations (OMOs) to influence the
money supply?
a. Buying and selling government securities
b. Adjusting interest rates directly
c. Controlling foreign exchange rates
d. Printing more currency
Answer: a. Buying and selling government securities
14. What is the Quantity Theory of Money primarily concerned with linking?
a. Inflation rate to real GDP
b. Inflation rate to money supply growth
c. Interest rate to investment
d. Money supply to government spending
Answer: b. Inflation rate to money supply growth
15. How is velocity defined in the Quantity Theory of Money?
a. The rate at which money is created
b. The number of times a unit of currency changes hands in a given time
c. The total value of transactions in an economy
d. The interest rate on loans
Answer: b. The number of times a unit of currency changes hands in a given

time
16. What is the Quantity Equation in the Quantity Theory of Money?
a. M + V = P + Y
b. M × V = P × Y
c. P × Y = M + V
d. P + Y = M × V
Answer: b. M × V = P × Y
17. According to the Quantity Equation, what does an increase in the money supply (M)
cause?
a. Increase in velocity (V)
b. Decrease in prices (P)
c. Increase in real GDP (Y)
d. Increase in inflation rate
Answer: d. Increase in inflation rate
18. How does the central bank control the money supply through reserve requirements?
a. Buying and selling government securities
b. Adjusting interest rates
c. Changing the percentage of deposits banks must hold in reserve
d. Printing more currency
Answer: c. Changing the percentage of deposits banks must hold in reserve
19. What is the relationship between an expansionary monetary policy and the money
supply?
a. Increases the money supply
b. Decreases the money supply
c. No effect on the money supply
d. Uncertain effect on the money supply
Answer: a. Increases the money supply
20. Q: In the Quantity Theory of Money, what does the variable P represent?
a. Money supply
b. Velocity
c. Prices
d. Real GDP
Answer: c. Prices
Q&A:
1. What is the effect on national saving (S) when the government increases defense
spending (G > 0)?
o A: National saving decreases as G increases.
2. How does a big tax cut (T < 0) affect consumption (C) and saving (S) in the model?
o A: C increases, and S decreases.
3. In the context of the model, what happens to the real interest rate when there is an
increase in the deficit?
o A: The real interest rate rises, leading to a reduction in the level of investment.
4. Why does an increase in the deficit reduce saving in the model?
o A: An increase in the deficit reduces national saving because government
spending (G) is a component of aggregate demand, and an increase in G reduces
saving.
5. How does an increase in desired investment impact the interest rate (r) in the
o A: It raises the interest rate.
6. What is the key limitation when there is an increase in desired investment in the
o A: The equilibrium level of investment cannot increase because the supply of
loanable funds is fixed.
7. When saving depends on the interest rate (r), how does an increase in desired
investment affect saving and the interest rate?
o A: It raises both saving and the interest rate.
8. In the Classical Theory of Inflation, which assumption is made about prices and
markets?
o A: Prices are assumed to be flexible, and markets clear.
9. Define inflation in economics.
o A: Inflation is a rise in the general level of prices of goods and services in an
economy over a period of time.
10. How is the inflation rate defined, and what does it measure?
o A: The inflation rate is the percentage change in a price index over time,
measuring the increase in the average level of prices.
11. What is the focus of the Quantity Theory of Money?
o A: It links the inflation rate to the growth rate of the money supply.
12. What is velocity in the Quantity Theory of Money, and how is it defined?
o A: Velocity is the rate at which money circulates, defined as the number of times
the average unit of currency changes hands in a given time.
13. State one of the functions of money.
o A: Medium of exchange.
14. What is the ease with which money can be converted into other assets called?
o A: Liquidity.
15. Which type of money has no intrinsic value?
o A: Fiat money.
16. Who conducts monetary policy in a country, and what is one tool used in monetary
policy?
o A: The central bank; Open Market Operations (OMOs).
17. How does the central bank expand the money supply using OMOs?
o A: By buying Treasury Bills and paying for them with new money.
18. What is the Quantity Equation in the Quantity Theory of Money?
o A: M×V=P×YM×V=P×Y.
19. How does the central bank control the money supply through reserve requirements?
o A: By changing the percentage of deposits that banks must hold in reserve.
20. According to the Quantity Equation, what does an increase in the money supply (M)
cause?
o A: It causes an increase in the inflation rate.
Lesson 11
MONEY AND INFLATION (CONTINUED)
MCQs:
1. What does M1 include in addition to currency?
a. Small time deposits
b. Demand deposits
c. Large time deposits
d. Repurchase agreements
Answer: b. Demand deposits
2. What is the symbol for assets included in M3?
a. C
b. M1
c. M2
d. M
Answer: d. M
3. According to the quantity equation, what does M × V equal?
a. P × Y
b. M/P
c. P
d. Y
Answer: a. P × Y
4. What does the quantity theory of money predict regarding the relationship between
money growth and inflation?
a. No relationship
b. Positive relationship
c. Negative relationship
d. Exponential relationship
Answer: b. Positive relationship
5. What does the Fisher effect describe?
a. Relationship between money growth and inflation
b. Relationship between real and nominal interest rates
c. Relationship between M1 and M2
d. Relationship between currency and demand deposits
Answer: b. Relationship between real and nominal interest rates
6. What is the main purpose of seigniorage?
a. Controlling inflation
b. Raising revenue without raising taxes or selling bonds
c. Determining interest rates
d. Regulating money supply
Answer: b. Raising revenue without raising taxes or selling bonds
7. What does the inflation tax refer to?
a. Tax on income
b. Tax on spending
c. Tax on people who hold money
d. Tax on exports
Answer: c. Tax on people who hold money
8. According to the Fisher equation, what is the relationship between nominal interest
rate (i) and real interest rate (r)?
a. i = r
b. i > r
c. i < r
d. i = r + π
Answer: d. i = r + π
9. What is the main factor determining the real interest rate (r)?
a. Money supply growth
b. Inflation rate
c. Quantity of money
d. Savings and investment balance (S = I)
Answer: d. Savings and investment balance (S = I)
10. In the quantity equation, what does (M/P)d stand for?

a. Real money balances
b. Nominal money supply
c. Velocity of money
d. Inflation rate
Answer: a. Real money balances
11. What is the symbol for large time deposits in the money supply measures?
a. M1
b. M2
c. M3
d. C
Answer: c. M3
12. How is the inflation rate denoted in the quantity theory of money?
a. π
b. M
c. V
d. P
Answer: a. π
13. What does the Fisher effect predict regarding the relationship between inflation and
nominal interest rates?
a. Positive relationship
b. Negative relationship
c. No relationship
d. Exponential relationship
Answer: a. Positive relationship

14. What is the primary determinant of the quantity of real money balances demanded
in the simple money demand function?
a. Nominal income (Y)
b. Inflation rate (π)
c. Velocity of money (V)
d. Money supply (M)
Answer: a. Nominal income (Y)
15. What is the connection between the simple money demand function and the
quantity equation?
a. k = 1/V
b. k = V
c. k = P/Y
d. k = M/P
Answer: a. k = 1/V
16. According to the quantity theory of money, what happens to inflation when money
growth exceeds the amount required for normal economic growth?
a. Inflation decreases
b. Inflation remains constant
c. Inflation increases
d. Inflation becomes negative
Answer: c. Inflation increases
17. How is the real interest rate (r) related to the nominal interest rate (i) and the
inflation rate (π)?
a. r = i + π
b. r = i - π
c. r = i / π
d. r = π - i
Answer: b. r = i - π
18. What is the Fisher equation used to determine?
a. Velocity of money
b. Money supply growth
c. Real interest rate
d. Inflation rate
Answer: c. Real interest rate
19. What does the quantity theory of money assume about the velocity of money (V)?
a. V is constant
b. V increases with inflation
c. V is inversely proportional to money supply
d. V is irrelevant in the theory
Answer: a. V is constant
20. How is the relationship between inflation and money growth depicted in the graph
provided?
a. Positive correlation
b. Negative correlation
c. No correlation
d. Exponential correlation
Answer: a. Positive correlation
Q&A:
1. Define M1 in the context of money supply measures.
Answer: M1 includes currency, demand deposits, travelers’ checks, and other checkable
deposits.
2. What assets are included in M2?
Answer: M2 includes small time deposits, savings deposits, money market mutual funds,
and money market deposit accounts, in addition to M1.
3. Explain the simple money demand function and its components.
Answer: The simple money demand function is (M/P)d = kY, where k represents how
much money people wish to hold for each unit of income (exogenous).
4. How is the quantity of real money balances demanded related to real income?
Answer: The quantity of real money balances demanded is proportional to real income,
as expressed by the equation (M/P)d = kY.
5. What does the quantity equation (M × V = P × Y) represent?
Answer: The quantity equation represents the total money supply (M × V) equaling the
total spending on goods and services (P × Y).
6. Describe the connection between the simple money demand function and the
velocity of money (V).
Answer: The connection is given by k = 1/V. When people hold lots of money relative to
their incomes (k is high), money changes hands infrequently (V is low).
7. Explain the Quantity Theory of Money in terms of growth.
Answer: The Quantity Theory of Money predicts a one-for-one relation between changes
in the money growth rate and changes in the inflation rate.
8. What does the Fisher equation (i = r + π) describe?
Answer: The Fisher equation describes the relationship between nominal interest rate (i),
real interest rate (r), and the inflation rate (π).
9. How does the Fisher effect explain the relationship between inflation and nominal
interest rates?
Answer: An increase in inflation (π) causes an equal increase in nominal interest rates
(i), as per the Fisher effect.
10. Define seignior age and its role in government finance.
Answer: Seignior age is the revenue raised by the government from printing money. It
allows the government to spend more without raising taxes or selling bonds.
11. What is the inflation tax, and how is it related to printing money?
Answer: The inflation tax refers to the effect of printing money to raise revenue, causing
inflation. Inflation is like a tax on people who hold money.
12. Differentiate between nominal interest rate (i) and real interest rate (r).
Answer: Nominal interest rate (i) is not adjusted for inflation, while real interest rate (r)
is adjusted for inflation (r = i - π).
13. Explain the role of S = I in determining the real interest rate.
Answer: S = I determines the real interest rate (r). An increase in inflation (π) causes an
equal increase in nominal interest rates (i), maintaining the one-for-one relationship
known as the Fisher effect.
14. How is the relationship between money growth and inflation depicted in the
provided graph?
Answer: The graph illustrates a positive correlation between inflation and money growth.
15. According to the Quantity Theory of Money, what does normal economic growth
require in terms of money supply growth?
Answer: Normal economic growth requires a certain amount of money supply growth to
facilitate the growth in transactions.
16. What does the quantity theory assume about the velocity of money (V)?
Answer: The quantity theory assumes that V is constant (ΔV/V = 0).
17. How does the Quantity Theory of Money explain the relationship between changes
in the money growth rate and changes in the inflation rate?
Answer: The theory predicts a one-for-one relation between changes in the money
growth rate and changes in the inflation rate.
18. What factors does ΔY/Y depend on, according to the Quantity Theory of Money?
Answer: ΔY/Y depends on growth in the factors of production and technological

progress.
19. How is the growth rate of a product expressed in the quantity equation in growth
rates?
Answer: The growth rate of a product is expressed as the sum of the growth rates in the
quantity equation in growth rates.
20. In terms of money supply measures, what assets are included in M3?
Answer: M3 includes large time deposits, repurchase agreements, and institutional

money market mutual fund balances, in addition to M2.
Lesson 12
MCQs:
1. What is the given value for the growth rate of money supply (M)?
A) 2%
B) 4%
C) 5%
D) 7%
Answer: C) 5%
2. If the nominal interest rate is calculated as i = r + π, what is the value of i when r = 4

and π = 3?
A) 5
B) 6
C) 7
D) 8
Answer: C) 7
3. What happens to Δi if the central bank increases the money growth rate by 2
percentage points per year?
A) Δi = 0
B) Δi = 1
C) Δi = 2
D) Δi = 3
Answer: C) Δi = 2
4. If the growth rate of real income (Y) falls to 1% per year, what will happen to the
inflation rate (π)?
A) π remains the same
B) π increases by 1%
C) π decreases by 1%
D) π increases by 2%
Answer: B) π increases by 1%
5. What action must the central bank take to keep inflation (π) constant if real income
(Y) is falling?
A) Increase money growth rate
B) Decrease money growth rate
C) Keep money growth rate constant
D) Increase nominal interest rate
Answer: B) Decrease money growth rate
6. What is the ex ante real interest rate defined as?
A) i - π
B) i + π
C) i × π
D) i ÷ π
Answer: A) i - π
7. In the Quantity Theory of Money, what determines the demand for real money
balances?
A) Nominal interest rate
B) Real income (Y)
C) Expected inflation (πe)
D) Actual inflation rate (π)
Answer: B) Real income (Y)
8. How does an increase in the nominal interest rate (i) affect money demand?
A) Increases money demand
B) Decreases money demand
C) No effect on money demand
D) Inverts the money demand curve
Answer: B) Decreases money demand
9. What is the relevant nominal interest rate for money demand when considering
inflation expectations?
A) i
B) r
C) i + πe
D) r + π
Answer: C) i + πe
10. Where does equilibrium occur in the money market?
A) Where nominal interest rate is highest
B) Where real money supply equals real money demand

C) Where inflation rate is lowest
D) Where real income is highest
Answer: B) Where real money supply equals real money demand
11. What variable adjusts to ensure that saving equals investment in the long run?
A) Money supply (M)
B) Nominal interest rate (i)
C) Real income (Y)
D) Expected inflation (πe)
Answer: C) Real income (Y)
12. How does price (P) respond to a change in the money supply (M), according to the
Quantity Theory of Money?
A) Proportional change
B) Inversely proportional change
C) No change
D) Unpredictable change
Answer: A) Proportional change
13. What happens to expected inflation (πe) in the short run when people receive new
information about future money supply increases?
A) πe remains unchanged
B) πe increases
C) πe decreases
D) πe becomes unpredictable
Answer: B) πe increases
14. What is the Fisher effect related to?

A) Money supply changes
B) Expected inflation changes
C) Nominal interest rate changes
D) Real income changes
Answer: C) Nominal interest rate changes
15. In the long run, what is the average relationship between expected inflation (πe) and
actual inflation (π)?
A) πe > π
B) πe < π
C) πe = π
D) πe varies randomly from π
Answer: C) πe = π
16. How does the nominal interest rate (i) respond to an increase in expected inflation
(πe)?
A) i increases
B) i decreases
C) i remains constant
D) i becomes unpredictable
Answer: A) i increases
17. What equation represents the money demand function that includes the nominal
interest rate (i) and real income (Y)?
A) M/P=L(i,Y)M/P=L(i,Y)
B) M/P=L(r+πe,Y)M/P=L(r+πe,Y)
C) M/P=L(r,Y+πe)M/P=L(r,Y+πe)
D) M/P=L(r,Y)M/P=L(r,Y)
Answer: B) M/P=L(r+πe,Y)M/P=L(r+πe,Y)
18. In the long run, how does a change in money supply (M) affect the price level (P)?
A) No effect on P
B) Direct proportionality with P
C) Inverse proportionality with P
D) Unpredictable effect on P
Answer: B) Direct proportionality with P
19. What variable adjusts to re-establish equilibrium when there is a change in expected
inflation (πe)?
A) Real income (Y)
B) Nominal interest rate (i)
C) Money supply (M)
D) Price level (P)
Answer: B) Nominal interest rate (i)
20. How does a decrease in money demand affect the equilibrium in the money market?
A) Creates excess supply of money
B) Creates excess demand for money
C) No effect on equilibrium
D) Causes inflationary pressures
Answer: B) Creates excess demand for money
Q&A:
1: What are the given values in the exercise?
A: V is constant, M is growing 5% per year, Y is growing 2% per year, and r = 4.

2: How is nominal interest rate (i) calculated in the given exercise?
A: i = r + π, where r is the real interest rate and π is the inflation rate.
3: If the money growth rate increases by 2 percentage points per year, what is the change in
the nominal interest rate (∆i)?
A: ∆i = 2, the same as the increase in the money growth rate.
4: What is the formula for ex ante real interest rate in the context of this exercise?
A: i – πe = ex ante real interest rate
5: Define ex post real interest rate as mentioned in the exercise.
A: i – π = ex post real interest rate, representing what people actually end up earning on their
bond or paying on their loan.
6: According to the Quantity Theory of Money, what is assumed to be the determinant of

the demand for real money balances?
A: The Quantity Theory of Money assumes that the demand for real money balances depends
only on real income Y.
7: How does the nominal interest rate affect money demand, according to the Quantity
Theory of Money?
A: An increase in the nominal interest rate (∆i) leads to a decrease in money demand.
8: In the context of money demand, what is the Quantity Theory of Money assuming about
the relationship between nominal interest rate and money demand?
A: The Quantity Theory of Money assumes that an increase in the nominal interest rate (∆i)
results in a decrease in money demand.
9: What is the formula for the money demand function (M/P)d in the given exercise?
A: (M/P)d = L(r + πe, Y)
10: What is the relevance of the nominal interest rate (r + πe) when people are deciding
whether to hold money or bonds?
A: The nominal interest rate relevant for money demand is r + πe.
11: Define equilibrium in the context of the given exercise.
A: Equilibrium occurs where the supply of real money balances equals real money demand.
12: What determines the variable "M" in the long run in the given exercise?
A: M is exogenous and determined by the State Bank of Pakistan (SBP).
13: How does the price level (P) respond to a change in money supply (∆M) in the long
run?
A: For given values of r, Y, and πe, a change in M causes P to change by the same percentage,
following the Quantity Theory of Money.
14: Over the long run, what is the average expectation regarding expected inflation (πe)?
A: Over the long run, people don’t consistently over- or under-forecast inflation, so πe = π on
average.
15: In the short run, what might cause a change in expected inflation (πe)?
A: In the short run, πe may change when people get new information, such as announcements by
the State Bank of Pakistan.
16: How does the Fisher effect relate to changes in expected inflation (πe)?
A: An increase in expected inflation (∆πe) leads to an increase in the nominal interest rate (i),
known as the Fisher effect.
17: In response to a change in expected inflation (∆πe), how does the demand for real
money balances change?
A: ∆πe leads to ∆i, and this, in turn, leads to a fall in the demand for real money balances to re-
establish equilibrium.
18: What does "YP adjusts to make" signify in the context of the given exercise?
A: YP (potential output) adjusts to make savings equal to investment (S = I) in the long run.
19: How does the price level (P) respond to a change in expected inflation (∆πe)?
A: An increase in expected inflation (∆πe) leads to a rise in the price level (P).
20: To prevent inflation from rising, what action must the State Bank of Pakistan (SBP)
take, according to the provided answers?
A: To prevent inflation from rising, SBP must reduce the money growth rate by 1 percentage
point per year.
Lesson 13
MCQs:
1. What is a common misperception about inflation?
A. Inflation always reduces real wages
B. Inflation has no impact on real wages
C. Inflation reduces real wages only in the long run
D. Inflation reduces real wages only in the short run
Answer: D
2. According to the classical view, why is inflation considered a social problem?
A. It leads to a decrease in real wages
B. It is merely a change in units of measurement
C. It causes excessive money supply growth
D. It results in hyperinflation
Answer: B
3. What are the two categories of social costs associated with inflation?
A. Direct and Indirect costs
B. Short-term and Long-term costs
C. Costs when inflation is expected and Additional costs when inflation is different
than expected
D. Monetary and Fiscal costs
Answer: C
4. What is the shoe leather cost associated with inflation?
A. The cost of changing prices
B. The cost of reducing money balances to avoid the inflation tax
C. The cost of general inconvenience
D. The cost of relative price distortions
Answer: B
5. Which of the following is an example of a menu cost?
A. Shoe leather cost
B. General inconvenience cost
C. Changing prices of goods in response to inflation
D. Printing new menus and catalogs
Answer: D
6. What is the primary consequence of relative price distortions caused by menu costs?
A. Microeconomic efficiencies
B. Increased tax treatment
C. Unfair tax treatment

D. Distorted allocation of resources
Answer: D
7. Why does inflation lead to unfair tax treatment?
A. Taxes are adjusted to account for inflation
B. Some taxes are not adjusted for inflation
C. Inflation increases real income
D. Inflation decreases tax rates
Answer: B
8. What is one benefit of moderate inflation in labor markets?
A. It increases nominal wages
B. It allows real wages to reach equilibrium levels without nominal wage cuts
C. It reduces uncertainty
D. It eliminates hyperinflation
Answer: B
9. When is inflation considered hyperinflation?
A. When the inflation rate exceeds 10%
B. When the inflation rate exceeds 20%
C. When the inflation rate exceeds 30%
D. When the inflation rate exceeds 50% per month
Answer: D
10. What is the primary cause of hyperinflation?
A. Decrease in real wages
B. Excessive money supply growth

C. Fiscal restraint
D. Decrease in nominal wages
Answer: B
11. Why do governments resort to printing money, leading to hyperinflation?
A. To increase real wages
B. To decrease uncertainty
C. When they cannot raise taxes or sell bonds
D. To eliminate inflation
Answer: C
12. What is the suggested solution to hyperinflation in theory?
A. Print more money
B. Implement fiscal restraint
C. Increase nominal wages
D. Decrease real wages
Answer: B
13. What may happen to the functioning of money under hyperinflation?
A. Money ceases to function as a store of value
B. Money becomes more stable
C. Money functions better as a medium of exchange
D. Money becomes a reliable unit of account
Answer: A
14. What term is used for arbitrary redistributions of purchasing power under
unexpected inflation?
A. Menu costs
B. Hyperinflation
C. Shoe leather cost
D. Relative price distortions
Answer: B
15. What is a consequence of increased uncertainty during high inflation?
A. Decreased risk aversion
B. More predictable outcomes
C. Arbitrary redistributions of wealth become less likely
D. Risk-averse people become worse off
Answer: D
16. How does hyperinflation impact transactions?
A. Transactions become smoother
B. People conduct transactions with barter or a stable foreign currency
C. Transactions become more predictable
D. Money becomes a more stable store of value
Answer: B
17. What is the long-run determinant of real wages according to the text?
A. Inflation rate
B. Nominal wages
C. Labor supply and the marginal product of labor
D. Hyperinflation
Answer: C
18. In the long run, what determines the real wage?

A. Inflation rate
B. Contracts
C. Labor supply and the marginal product of labor
D. Nominal wages
Answer: C
19. What is the classical view of a change in the price level?
A. It is a change in units of measurement
B. It is a change in real income
C. It is a change in nominal wages
D. It is a change in hyperinflation
Answer: A
20. What is the main benefit of inflation according to the text?
A. It reduces real wages
B. It eliminates uncertainty
C. It allows nominal wages to reach equilibrium levels without cuts
D. It decreases money supply growth
Answer: C
Q&A:
1: What is the common misperception about inflation regarding real wages?
A: The common misperception is that inflation reduces real wages, which is true only in the
short run when nominal wages are fixed by contracts.
2: According to the classical view of inflation, what is a change in the price level considered
to be?
A: The classical view states that a change in the price level is merely a change in the units of
measurement.
3: What are the two categories into which the social costs of inflation are divided?
A: The social costs of inflation fall into two categories: costs when inflation is expected and
additional costs when inflation is different than people had expected.
4: Explain the "shoe leather cost" associated with expected inflation.
A: Shoe leather cost refers to the costs and inconveniences of reducing money balances to avoid
the inflation tax. As inflation increases, real money balances decrease, leading to more frequent
trips to the bank.
5: What are menu costs in the context of inflation?
A: Menu costs are the costs of changing prices. For example, firms incur expenses to print new
menus or catalogs when inflation necessitates price adjustments.
6: How does inflation contribute to relative price distortions and microeconomic

inefficiencies?
A: Firms facing menu costs change prices infrequently. This leads to relative price distortions as
different firms change prices at different times, causing microeconomic inefficiencies in the
allocation of resources.
7: Provide an example of unfair tax treatment associated with inflation.
A: Some taxes, such as the capital gains tax, are not adjusted for inflation. This results in
individuals paying taxes on nominal gains even when there is no real gain, leading to unfair tax
treatment.
8: What is one of the general inconveniences caused by inflation?
A: Inflation makes it harder to compare nominal values from different time periods,
complicating long-range financial planning.
9: What are the additional costs of unexpected inflation?
A: Additional costs of unexpected inflation include arbitrary redistributions of purchasing power,

where some gain at others' expense, especially in long-term contracts not indexed to inflation
expectations.
10: Why does high inflation contribute to increased uncertainty?

A: High inflation is more variable and unpredictable, leading to greater uncertainty. Differences
between actual inflation and expected inflation become larger and more frequent, making risk-
averse individuals worse off.
11: What is one benefit of moderate inflation in labor markets?
A: Moderate inflation allows real wages to reach equilibrium levels without nominal wage cuts,
improving the functioning of labor markets.
12: Define hyperinflation and specify the threshold for hyperinflation.
A: Hyperinflation is defined as inflation with a rate equal to or exceeding 50% per month.
13: What is the primary cause of hyperinflation?
A: Hyperinflation is caused by excessive money supply growth. When the central bank prints
money rapidly, the result can be hyperinflation.
14: Why might a government resort to printing money, leading to hyperinflation?
A: When a government cannot raise taxes or sell bonds, it may finance spending increases by
printing money. This can lead to hyperinflation.
15: According to the text, what is the theoretical solution to hyperinflation?
A: The theoretical solution to hyperinflation is to stop printing money. However, in the real
world, this requires drastic and painful fiscal restraint.
16: In the context of hyperinflation, what happens to the function of money?
A: Under hyperinflation, money ceases to function as a store of value, and it may not serve its
other functions, such as a unit of account or a medium of exchange.
17: What is the impact of hyperinflation on transactions, according to the text?
A: Under hyperinflation, people may resort to conducting transactions with barter or a stable
foreign currency, as money loses its functionality.
18: Summarize the relationship between excessive money supply growth and
hyperinflation.
A: Hyperinflation is caused by excessive money supply growth. When the central bank rapidly
prints money, it leads to a significant increase in the price level.
19: Why is stopping hyperinflation challenging in the real world?

A: Stopping hyperinflation in the real world requires drastic and painful fiscal restraint, which
can be challenging for governments.
20: In what circumstances does inflation allow real wages to reach equilibrium levels
without nominal wage cuts?
A: Inflation allows real wages to reach equilibrium levels without nominal wage cuts,
particularly in the case of moderate inflation.
Lesson 14
THE OPEN ECONOMY
MCQs:
1. What are real variables in economics?
a) Measured in money units
b) Measured in physical units
c) Measured in percentage points
d) Measured in nominal terms
Answer: b) Measured in physical units
2. Which of the following is a nominal variable?
a) Real wage
b) Real interest rate
c) Nominal wage
d) Quantity of output
Answer: c) Nominal wage
3. What does the Classical Dichotomy suggest?
a) Real and nominal variables are interchangeable
b) Nominal variables do not affect real variables

c) Real variables do not exist in classical economics
d) Money supply is always neutral
Answer: b) Nominal variables do not affect real variables
4. According to the Neutrality of Money, what happens in the long run when the
money supply changes?
a) Real variables are significantly impacted
b) Real variables remain unaffected
c) Nominal variables disappear
d) Nominal variables become more important
Answer: b) Real variables remain unaffected
5. In an open economy, what does Net Exports (NX) represent?
a) Trade surplus
b) Trade deficit
c) Both a and b
d) Neither a nor b
Answer: c) Both a and b
6. What is the formula for GDP in an open economy?
a) Y = C + I + G
b) Y = C + I + G + NX
c) Y = C - I - G
d) Y = NX - G
Answer: b) Y = C + I + G + NX
7. If NX is positive, what does it indicate about the country's trade balance?
a) Trade surplus
b) Trade deficit
c) Balanced trade
d) No impact on trade
Answer: a) Trade surplus
8. What is the National Income Identity in an open economy?
a) Y = C + I
b) Y = C + I + G
c) Y = C + I + G + NX
d) Y = C + G
Answer: c) Y = C + I + G + NX
9. What is the relationship between Net Foreign Investment and Trade Balance?
a) They are unrelated
b) Net Foreign Investment equals Trade Balance
c) Net Foreign Investment is the inverse of Trade Balance
d) Trade Balance is part of Net Foreign Investment
Answer: b) Net Foreign Investment equals Trade Balance
10. When S > I, what is the country's position in terms of capital flows?
a) Net borrower
b) Net lender
c) No impact on capital flows
d) Trade deficit
Answer: b) Net lender
11. What is Net Capital Outflows in an open economy?

a) Net inflow of loanable funds
b) Net purchases of domestic assets
c) Net purchases of foreign assets
d) Both a and c
Answer: d) Both a and c
12. In a small open economy, what does perfect capital mobility imply?
a) Restrictions on international trade in assets
b) No impact on the world interest rate
c) Dependence on the world interest rate
d) Trade deficit
Answer: b) No impact on the world interest rate
13. What does the production function (Y = F(K, L)) represent?
a) Consumption
b) Investment
c) Output
d) Trade balance
Answer: c) Output
14. What is the equation for the consumption function?
a) C = Y - T
b) C = Y - I
c) C = Y - G
d) C = Y - T - I
Answer: a) C = Y - T
15. In the National Saving equation, what does S – I represent?
a) Trade balance
b) Net Foreign Investment
c) Consumption
d) Government spending
Answer: b) Net Foreign Investment
16. What is the assumption related to capital flows in a small open economy?
a) Perfect capital immobility
b) Imperfect substitutes for domestic and foreign bonds
c) Dependence on domestic bonds
d) No impact on international trade
Answer: b) Imperfect substitutes for domestic and foreign bonds
17. What is the key characteristic of a small open economy in relation to the world
interest rate?
a) It affects the world interest rate
b) It is affected by the world interest rate
c) It has no impact on the world interest rate
d) It determines the world interest rate
Answer: c) It has no impact on the world interest rate
18. What is the formula for national saving (S) in an open economy?
a) S = Y - C
b) S = Y - C - G
c) S = Y - T - C
d) S = Y - I
Answer: b) S = Y - C - G
19. According to the provided information, does national saving depend on the interest
rate?
a) Yes
b) No
c) It depends on the level of government spending
d) It depends on net exports
Answer: b) No
20. What is the significance of the term "Net Foreign Investment" in the context of an
open economy?
a) It represents the trade balance
b) It is the same as national saving
c) It is the difference between domestic saving and domestic investment
d) It is unrelated to capital flows
Answer: c) It is the difference between domestic saving and domestic investment
Q&A:
1. What is the fundamental difference between real and nominal variables in
economics?
o A: Real variables are measured in physical units, while nominal variables are
measured in money units.
2. Explain the Classical Dichotomy and its implication for real and nominal variables.
o A: The Classical Dichotomy is the theoretical separation of real and nominal
variables, suggesting that nominal variables do not affect real variables.
3. What does the Neutrality of Money state in the context of changes in the money
supply?
o A: Changes in the money supply do not affect real variables; money is
approximately neutral in the long run.
4. In an open economy, why may spending not necessarily equal output and saving
may not equal investment?
o A: In an open economy, spending includes both domestic and foreign goods,
leading to a potential mismatch between spending and output.
5. Define Net Exports (NX) and its relationship to the trade balance.
o A: NX is the net exports, calculated as exports minus imports. If NX > 0, there is
a trade surplus, and if NX < 0, there is a trade deficit.
6. What does the equation Y = C + I + G + NX represent in the context of an open
economy?
o A: It represents the National Income Identity in an open economy, where Y is
output, C is consumption, I is investment, G is government spending, and NX is
net exports.
7. Explain the relationship between national savings (S) and Net Foreign Investment
(NFI).
o A: S – I equals Net Foreign Investment (NFI), representing the difference
between domestic saving and domestic investment.
8. In terms of capital flows, what does it mean when a country has a positive Net
Foreign Investment?
o A: A positive Net Foreign Investment implies that the country is a net lender; it is
investing more abroad than foreigners are investing in the country.
9. Define Net Capital Outflows and its significance in an open economy.
o A: Net Capital Outflows represent the net outflow of "loanable funds" or the net
purchases of foreign assets by a country.
10. When does a country become a net borrower in terms of international capital flows?
o A: A country becomes a net borrower when its domestic saving (S) is less than
domestic investment (I).
11. Explain the assumptions related to capital flows in a small open economy.
o A: Assumptions include perfect substitutability of domestic and foreign bonds and
perfect capital mobility with no restrictions on international trade in assets.
12. What is the role of Net Foreign Investment in relation to the Trade Balance?
o A: Net Foreign Investment is equal to the Trade Balance, representing the
difference between exports and imports.
13. How are Net Capital Outflows calculated, and what do they signify?
o A: Net Capital Outflows are calculated as S – I, representing the net purchases of
foreign assets. They signify a country's position as a net lender or borrower.
14. Explain the concept of perfect capital mobility in a small open economy.
o A: Perfect capital mobility implies no restrictions on international trade in assets,
and the economy is too small to affect the world interest rate.
15. Define the production function and its components.
o A: The production function (Y = F(K, L)) represents output and is a function of
capital (K) and labor (L).
16. What is the significance of the consumption function in the context of national
saving?
o A: The consumption function (C = Y - T) determines the level of consumption
based on disposable income.
17. How does a small open economy impact the world interest rate according to the
assumptions?
o A: In a small open economy, it cannot affect the world interest rate, denoted as r*.
18. What does the equation S – I = NX represent in the context of national saving and
the trade balance?
o A: It represents the equality between net saving (S – I) and the trade balance
(NX).
19. Discuss the significance of the assumption that domestic and foreign bonds are
perfect substitutes.
o A: This assumption simplifies the analysis and implies that investors can easily
switch between domestic and foreign bonds without affecting interest rates.
20. In the context of the loanable funds model, what does Net Capital Outflows
represent?
o A: Net Capital Outflows represent the net purchases of foreign assets and are a
key element in the open-economy version of the loanable funds model.
Lesson 15
THE OPEN ECONOMY (CONTINUED)
MCQs:
1. What are the three experiments discussed in the context of the open economy?
a) Monetary policy, fiscal policy, exchange rate
b) Fiscal policy at home, fiscal policy abroad, investment demand
c) Trade balance, budget deficit, interest rates
d) Net exports, government spending, inflation
Answer: b) Fiscal policy at home, fiscal policy abroad, investment demand
2. In the context of fiscal policy at home, what happens to saving when there is an
increase in government spending (G) or a decrease in taxes (T)?
a) Saving increases
b) Saving decreases
c) Saving remains unchanged
d) Saving becomes negative
Answer: b) Saving decreases
3. What does the term "NX" represent in the first experiment of fiscal policy at home?
a) Net exports
b) Net expenditures
c) National expansion
d) Nominal exchange
Answer: a) Net exports
4. In the first experiment, what is the impact on the budget deficit when there is an
increase in government spending (G) or a decrease in taxes (T)?
a) Budget deficit increases
b) Budget deficit decreases
c) Budget deficit remains unchanged
d) Budget moves to surplus
Answer: a) Budget deficit increases
5. What happens to net exports (NX) when there is an increase in government

spending (G) or a decrease in taxes (T) in the fiscal policy at home?
a) NX increases
b) NX decreases
c) NX remains unchanged
d) NX becomes negative
Answer: b) NX decreases
6. In the second experiment of fiscal policy abroad, what is the impact on the world
interest rate when there is expansionary fiscal policy abroad?
a) World interest rate increases
b) World interest rate decreases
c) World interest rate remains unchanged
d) World interest rate becomes negative
Answer: a) World interest rate increases

7. What is the result of an increase in investment demand in the third experiment?
a) Net exports (NX) increase
b) Net exports (NX) decrease
c) Net exports (NX) remain unchanged
d) Net exports (NX) become negative
Answer: b) Net exports (NX) decrease
8. What happens to net capital outflows and net exports when there is an increase in
investment demand?
a) Both increase
b) Both decrease
c) Net capital outflows increase, net exports decrease
d) Net capital outflows decrease, net exports increase
Answer: c) Net capital outflows increase, net exports decrease
9. In the third experiment, what is the impact on the world interest rate when
investment demand increases?
a) World interest rate increases
b) World interest rate decreases
c) World interest rate remains unchanged
d) World interest rate becomes negative
Answer: a) World interest rate increases
10. What is the relationship between the change in investment (ΔI) and the change in
saving (ΔS) in the third experiment?
a) ΔI > ΔS
b) ΔI < ΔS
c) ΔI = ΔS
d) ΔI is unrelated to ΔS
Answer: a) ΔI > ΔS
11. When net capital outflows and net exports fall in the third experiment, what is the
impact on the trade balance?
a) Trade balance increases
b) Trade balance decreases
c) Trade balance remains unchanged
d) Trade balance becomes negative
Answer: b) Trade balance decreases
12. What is the significance of the term "r1" in the context of the third experiment?*
a) Initial world interest rate
b) Final world interest rate
c) World interest rate during a recession
d) World interest rate during an expansion
Answer: a) Initial world interest rate
13. In the context of the third experiment, what does "I(r2)" represent?*
a) Investment at the initial world interest rate
b) Investment at the final world interest rate
c) Investment during a recession
d) Investment during an expansion
Answer: b) Investment at the final world interest rate
14. What is the impact of an increase in investment demand on the world interest rate
(r)?
a) r increases
b) r decreases
c) r remains unchanged
d) r becomes negative
Answer: a) r increases
15. In the third experiment, what is the relationship between ΔI and ΔS when ΔI > 0
and ΔS = 0?
a) Net exports increase
b) Net exports decrease
c) Net exports remain unchanged
d) Net exports become negative
Answer: b) Net exports decrease
16. When net exports fall in the third experiment, what happens to the world interest
rate (r2)?*
a) r2* increases
b) r2* decreases
c) r2* remains unchanged
d) r2* becomes negative
Answer: a) r2 increases*
17. What is the result of a positive ΔI and ΔS = 0 in the third experiment in terms of net
capital outflows and net exports?
a) Both increase
b) Both decrease
c) Net capital outflows increase, net exports decrease
d) Net capital outflows decrease, net exports increase
Answer: c) Net capital outflows increase, net exports decrease

18. In the context of the third experiment, what is the significance of the terms NX1 and
NX2?
a) Initial and final net exports
b) Initial and final net capital outflows
c) Initial and final world interest rates
d) Initial and final investments
Answer: a) Initial and final net exports
19. What does the equation ΔI > 0, ΔS = 0, and net capital outflows and net exports fall
by the amount ΔI represent in the third experiment?
a) Impact of fiscal policy
b) Impact of monetary policy
c) Impact of exchange rate changes
d) Impact of investment demand changes
Answer: d) Impact of investment demand changes
20. In the third experiment, what is the relationship between I(r1) and I(r2)?**
a) I(r1*) > I(r2*)
b) I(r1*) < I(r2*)
c) I(r1*) = I(r2*)
d) I(r1*) is unrelated to I(r2*)
Answer: b) I(r1) < I(r2)**
Q&A:
1. What are the three experiments discussed in the continued lesson on the open
economy?
o A: The experiments are fiscal policy at home, fiscal policy abroad, and an
increase in investment demand.
2. In the context of fiscal policy at home, what is the impact of an increase in
government spending (G) or a decrease in taxes (T) on saving?
o A: An increase in G or a decrease in T reduces saving.
3. What does the term "NX" represent in the first experiment of fiscal policy at home?
o A: NX represents net exports.
4. When there is an increase in government spending or a decrease in taxes in the
fiscal policy at home, what happens to the budget deficit?
o A: The budget deficit increases.
5. Describe the relationship between an increase in government spending or a decrease
in taxes and net exports (NX) in the fiscal policy at home.
o A: Net exports (NX) decrease.
6. In the second experiment of fiscal policy abroad, what is the impact on the world
interest rate when there is an expansionary fiscal policy abroad?
o A: Expansionary fiscal policy abroad raises the world interest rate.
7. What is the result of an increase in investment demand in the third experiment?
o A: Net exports (NX) decrease.
8. Explain the relationship between the change in investment (ΔI) and the change in
saving (ΔS) in the third experiment.
o A: ΔI > 0, ΔS = 0, net capital outflows, and net exports fall by the amount ΔI.
9. What is the significance of the term "r1" in the context of the third experiment?*
o A: r1* represents the initial world interest rate.
10. In the third experiment, what does "I(r2)" represent?*
o A: I(r2*) represents investment at the final world interest rate.
11. What is the impact of an increase in investment demand on the world interest rate
(r)?
o A: The world interest rate (r) increases.
12. When net exports fall in the third experiment, what happens to the world interest
rate (r2)?*
o A: r2* increases.
13. What is the result of a positive ΔI and ΔS = 0 in the third experiment in terms of net
capital outflows and net exports?
o A: Net capital outflows increase, net exports decrease.
14. What does the equation ΔI > 0, ΔS = 0, and net capital outflows and net exports fall
by the amount ΔI represent in the third experiment?
o A: It represents the impact of changes in investment demand.
15. In the third experiment, what is the relationship between I(r1) and I(r2)?**
o A: I(r1*) < I(r2*).
16. How does an expansionary fiscal policy abroad affect the world interest rate in the
second experiment?
o A: It raises the world interest rate.
17. What is the relationship between an increase in government spending or a decrease
in taxes and saving in the fiscal policy at home?
o A: An increase in G or a decrease in T reduces saving.
18. In the fiscal policy at home, what is the impact of a decrease in government
spending (G) or an increase in taxes (T) on saving?
o A: A decrease in G or an increase in T increases saving.
19. What happens to net capital outflows and net exports when there is an increase in
investment demand in the third experiment?
o A: Net capital outflows increase, net exports decrease.
20. What is the relationship between ΔI and ΔS when ΔI > 0 and ΔS = 0 in the third
experiment?
o A: Net exports decrease.
Lesson 16
THE OPEN ECONOMY (CONTINUED)
MCQs:
1. What does the accounting identity NX = S - I signify?
a. Net exports equal domestic savings
b. Net exports equal the difference between domestic savings and investment
c. Net exports equal the sum of domestic savings and investment
d. Net exports equal investment minus domestic savings
Answer: b
2. Why the net capital outflow curve is considered vertical?
a. Due to the dependence of S and I on ε
b. ε adjusts to equate NX with net capital outflow, S - I
c. S and I are independent of ε
d. ε determines the slope of the curve
Answer: c
3. In the foreign exchange market, what is the role of net capital outflow (S - I)?
a. It represents the demand for dollars
b. It represents the supply of dollars to be invested abroad
c. It determines the real exchange rate

d. It influences fiscal policy
Answer: b
4. What does the net exports function (NX = NX(ε)) reflect?
a. A direct relationship between net exports and ε
b. An inverse relationship between net exports and ε
c. The dependence of net exports on fiscal policy
d. The impact of trade policy on net exports
Answer: b
5. When ε is relatively low, what happens to net exports for the home country?
a. Net exports decrease
b. Net exports remain constant
c. Net exports increase
d. Net exports become negative
Answer: c
6. How does a fiscal expansion at home affect the real exchange rate and net exports?
a. Real exchange rate rises, and net exports fall
b. Real exchange rate falls, and net exports rise
c. Both real exchange rate and net exports rise
d. Both real exchange rate and net exports fall
Answer: a
7. What is the impact of an increase in investment demand on net exports and the real
exchange rate?
a. Net exports rise, and the real exchange rate falls
b. Net exports fall, and the real exchange rate rises

c. Both net exports and the real exchange rate rise
d. Both net exports and the real exchange rate fall
Answer: b
8. How does an increase in the world interest rate (r) affect the real exchange rate and
net exports?*
a. Real exchange rate falls, and net exports fall
b. Real exchange rate rises, and net exports rise
c. Both real exchange rate and net exports rise
d. Both real exchange rate and net exports fall
Answer: b
9. What happens to net exports when there is a trade policy to restrict imports?
a. Net exports rise
b. Net exports fall
c. Net exports remain unchanged
d. Net exports become negative
Answer: c
10. How does the nominal exchange rate (e) relate to the real exchange rate (ε)?
a. e is inversely proportional to ε
b. e is directly proportional to ε
c. e is independent of ε
d. e determines the value of ε
Answer: a
11. What determines the nominal exchange rate according to the given information?
a. Inflation and net exports

b. Real exchange rate and price levels
c. Interest rates and fiscal policy
d. Nominal GDP and investment
Answer: b
12. How is the expression for the real exchange rate related to the nominal exchange
rate and price levels?
a. It is inversely proportional to the nominal exchange rate
b. It is directly proportional to the nominal exchange rate
c. It is independent of the nominal exchange rate
d. It is determined by interest rates
Answer: b
13. What does the equation regarding inflation and nominal exchange rates suggest?
a. Inflation has no impact on nominal exchange rates
b. Inflation leads to depreciation of the exchange rate
c. Inflation causes appreciation of the exchange rate
d. Inflation and exchange rates are unrelated
Answer: c
14. In the graph, what does a negative inflation differential indicate?
a. Depreciation relative to the U.S. dollar
b. Appreciation relative to the U.S. dollar
c. No change in the exchange rate
d. A decrease in net exports
Answer: a
15. What is the relationship between inflation differential and the percentage change in
the nominal exchange rate?
a. Positive correlation
b. Negative correlation
c. No correlation
d. Inverse correlation
Answer: b
16. How does a fiscal expansion abroad impact net exports and the real exchange rate?
a. Net exports rise, and the real exchange rate falls
b. Net exports fall, and the real exchange rate rises
c. Both net exports and the real exchange rate rise
d. Both net exports and the real exchange rate fall
Answer: b
17. What effect does an import quota have on the demand for dollars and net exports?
a. Increases demand for dollars, leading to a rise in net exports
b. Decreases demand for dollars, leading to a fall in net exports
c. Has no impact on the demand for dollars or net exports
d. Causes a decrease in the supply of dollars
o Answer: a
18. In the context of trade policy, what remains fixed despite changes in demand for
dollars?
a. Nominal exchange rate
b. Real exchange rate
c. Net exports
d. Supply of dollars
Answer: d
19. What happens to the exchange rate when there is an increase in investment
demand?
a. Exchange rate falls
b. Exchange rate rises
c. Exchange rate remains unchanged
d. Exchange rate becomes negative
Answer: b
20. What does the expression Δε > 0 (demand increase) signify in the given context?
a. Increase in net exports
b. Increase in the real exchange rate
c. Increase in the demand for dollars
d. Increase in inflation differential
Answer: c
Q&A:
1. How is ε determined in the open economy?
o Answer: ε is determined to ensure that the accounting identity NX = S - I holds.
It adjusts to equate NX with net capital outflow, S - I.
2. Why is the net capital outflow curve considered vertical?
o Answer: The net capital outflow curve is vertical because neither savings (S) nor
investment (I) depend on ε. ε adjusts to equate NX with net capital outflow, S - I.
3. What role do foreigners and net capital outflow play in the foreign exchange
market?
o Answer: Foreigners' demand for dollars to buy U.S. net exports contributes to the
demand side, while net capital outflow (S - I) serves as the supply of dollars to be
invested abroad.
4. How does fiscal policy at home impact the real exchange rate and net exports?
o Answer: A fiscal expansion at home reduces national saving, net capital
outflows, and the supply of dollars, causing the real exchange rate to rise and net
exports to fall.
5. In fiscal policy abroad, what happens when ε is high enough?
o Answer: At high ε values, home goods become expensive, leading to a situation
where the country exports less than it imports, resulting in a trade deficit.
6. How does an increase in the world interest rate (r) affect the real exchange rate and
net exports?*
o Answer: An increase in r* leads to higher net capital outflows, increasing the
supply of dollars. This causes the real exchange rate to fall and net exports to rise.
7. What is the impact of an increase in investment demand on the foreign exchange
market?
o Answer: An increase in investment demand reduces net capital outflows, causing
the real exchange rate to rise and net exports to fall.
8. How does a trade policy to restrict imports, such as an import quota, affect the
foreign exchange market?
o Answer: An import quota increases demand for dollars, shifting the demand
curve right. However, it doesn't affect S or I, so the supply of dollars remains
fixed.
9. Explain the results of the trade policy experiment, specifically Δε, ΔNX, ΔIM, and
ΔEX.
o Answer: The results are Δε > 0 (demand increase), ΔNX = 0 (supply fixed), ΔIM
< 0 (policy effect), and ΔEX < 0 (rise in ε causing a depreciation).
10. What determines the nominal exchange rate (e) according to the information
provided?
o Answer: The nominal exchange rate (e) depends on the real exchange rate (ε) and
the price levels at home and abroad.
11. How is the expression for the real exchange rate related to the nominal exchange
rate and price levels?
o Answer: The expression for the real exchange rate is related to the nominal
exchange rate and price levels through the formula e = ε * (P/P*).
12. In terms of growth rates, how can the equation for the nominal exchange rate be
rewritten?
o Answer: The equation for the nominal exchange rate can be rewritten in terms of
growth rates, showing the relationship between inflation and nominal exchange
rates.
13. Explain the relationship between inflation and nominal exchange rates.
o Answer: Inflation and nominal exchange rates are positively related. An increase
in inflation leads to an increase in the nominal exchange rate.
14. How does the inflation differential impact the depreciation or appreciation of the
exchange rate?
o Answer: A negative inflation differential indicates depreciation relative to the
U.S. dollar, while a positive differential indicates appreciation.
15. What is the significance of the percentage change in the nominal exchange rate in
the context of inflation differential?
o Answer: The percentage change in the nominal exchange rate reflects the
depreciation or appreciation of a currency relative to the U.S. dollar based on the
inflation differential.
16. How does a fiscal expansion abroad affect the real exchange rate and net exports?
o Answer: A fiscal expansion abroad leads to higher national saving, increased net
capital outflows, and a higher supply of dollars. This causes the real exchange rate
to fall and net exports to rise.
17. What effect does an import quota have on the demand for dollars and net exports?
o Answer: An import quota increases the demand for dollars, leading to a rise in
net exports.
18. What remains fixed in the foreign exchange market despite changes in the demand
for dollars due to trade policy?
o Answer: The supply of dollars remains fixed in the foreign exchange market
despite changes in demand due to trade policy.
19. How does an increase in investment demand impact the exchange rate?
o Answer: An increase in investment demand leads to a higher real exchange rate
and a decrease in net exports.
20. What does the expression Δε > 0 (demand increase) signify in the given context?
o Answer: The expression signifies an increase in the demand for dollars, leading
to a positive change in the real exchange rate.
Lesson 17
ISSUES IN UNEMPLOYMENT
MCQs:
1. What does Purchasing Power Parity (PPP) state?
a. Goods must sell at different prices in all countries.
b. Goods must sell at the same (currency-adjusted) price in all countries.
c. Goods must sell at the lowest possible price.
d. Goods must sell at the highest possible price.
Answer: b
2. What does PPP imply about the nominal exchange rate between two countries?
a. It depends on international arbitrage.
b. It equals the ratio of the countries' price levels.
c. It is not related to price levels.
d. It is constant over time.

Answer: b
3. If e = P/P, what does έ = 1 signify?*
a. Perfect substitution between goods in different countries
b. Imperfect substitution between goods in different countries
c. Failure of PPP in the real world
d. Unattainable equilibrium in the foreign exchange market
Answer: a
4. Why doesn't PPP hold in the real world?
a. Due to the law of one price.
b. International arbitrage is not possible for various reasons, including non-traded goods
and transportation costs.
c. Goods of different countries are perfect substitutes.
d. Nominal exchange rates always equal PPP values.
Answer: b
5. What is the natural rate of unemployment?
a. The maximum attainable level of employment in an economy.
b. The average rate of unemployment around which the economy fluctuates.
c. The minimum rate of unemployment achievable through government policies.
d. The rate of unemployment during a recession.
Answer: b
6. In a boom, what happens to the actual unemployment rate compared to the natural
rate?
a. It rises above the natural rate.
b. It falls below the natural rate.

c. It remains constant.
d. It equals the natural rate.
Answer: b
7. What does the steady-state condition in the labor market imply?
a. The unemployment rate is constant.
b. There is constant job turnover.
c. The economy is in a recession.
d. There is no unemployment.
Answer: a
8. In the context of transitions between employment and unemployment, what does the
equation s x E = f x U represent?
a. The steady-state condition.
b. The condition for equilibrium in the labor market.
c. The relationship between job separations and job findings.
d. The policy implication for reducing unemployment.
Answer: c
9. How is the natural rate of unemployment affected by policy changes?
a. It is not influenced by policies.
b. It decreases if job finding (f) increases or job separations (s) decrease.
c. It increases if job finding (f) decreases or job separations (s) increase.
d. It is inversely proportional to the inflation rate.
Answer: b
10. What is the primary reason for the existence of frictional unemployment?
a. Wage rigidity
b. Job search
c. Insufficient job opportunities
d. Technological unemployment
Answer: b
11. What does frictional unemployment result from?
a. Workers' reluctance to accept job offers.
b. Imperfect information about job vacancies and candidates.
c. Inflexibility of wage rates.
d. Lack of government intervention.
Answer: b
12. If job finding were instantaneous (f = 1), what would happen to the natural rate of
unemployment?
a. It would increase.
b. It would decrease.
c. It would remain constant.
d. It would become zero.
Answer: d
13. What is one reason why job finding (f) is less than 1?
a. Technological advancements
b. Wage rigidity
c. Job search
d. Full employment policies
Answer: c
14. What is the key factor causing frictional unemployment according to the
information provided?
a. Lack of government intervention
b. Job search
c. Wage rigidity
d. Technological unemployment
Answer: b
15. Why Purchasing Power Parity (PPP) is considered a useful theory despite its
limitations in the real world?
a. It accurately predicts nominal exchange rates.
b. It provides a simple and intuitive framework.
c. It eliminates all sources of international arbitrage.
d. It ensures perfect substitution of goods.
Answer: b
16. What is the significance of the equation e x P = P in Purchasing Power Parity

(PPP)?*
a. It defines the natural rate of unemployment.
b. It represents the law of one price.
c. It shows the relationship between price levels and the nominal exchange rate.
d. It indicates the rate of job finding in the labor market.
Answer: c
17. In the context of PPP, what does the equation e = P/P solve for?*
a. The cost of a basket of foreign goods in domestic currency.
b. The cost of a basket of domestic goods in foreign currency.
c. The rate of job separations.

d. The natural rate of unemployment.
Answer: a
18. What does PPP imply about the cost of a basket of goods across countries?
a. It varies with the nominal exchange rate.
b. It is equalized by the nominal exchange rate.
c. It depends on international arbitrage.
d. It is unrelated to price levels.
Answer: b
19. What are the two main reasons PPP does not hold in the real world?
a. Wage rigidity and government intervention.
b. Non-traded goods and transportation costs.
c. Perfect substitution and imperfect information.
d. Recession and boom cycles.
Answer: b
20. What is the relationship between the nominal exchange rate and the price levels of
two countries according to PPP?
a. They are unrelated.
b. They are inversely proportional.
c. They are directly proportional.
d. They depend on the inflation rate.
Answer: c
Q&A:
1. What is the Purchasing Power Parity (PPP)?
o A: PPP is a doctrine stating that goods should have the same currency-adjusted
price in all countries.
2. What does PPP aim to equalize among countries?
o A: PPP aims to equalize the cost of a basket of goods across countries.
3. What is the formula for PPP?
o A: e×P=P∗e×P=P∗, where ee is the nominal exchange rate, PP is the cost of a
basket of domestic goods, and P∗P∗ is the cost of a basket of foreign goods.
4. What is the significance of arbitrage in PPP?
o A: Arbitrage, the law of one price, is the reason for PPP.
5. What does the nominal exchange rate equal in PPP?
o A: The nominal exchange rate equals the ratio of the countries' price levels.
6. Why doesn't PPP hold in the real world?
o A: PPP doesn't hold due to non-traded goods, transportation costs, and imperfect
substitution of goods.
7. Despite its limitations, why is PPP considered useful?
o A: PPP is considered useful for its simplicity and the tendency of nominal
exchange rates to approach PPP values in the long run.
8. What is the Natural Rate of Unemployment?
o A: The Natural Rate of Unemployment is the average rate around which the
economy fluctuates.
9. In what economic conditions does the actual unemployment rate rise above the
natural rate?
o A: In a recession, the actual unemployment rate rises above the natural rate.
10. How is the unemployment rate calculated in the given model?
o A: ULLU, where UU is the number of unemployed, and LL is the number of
workers in the labor force.
11. What is the steady-state condition for the labor market?
o A: The steady-state condition is s×E=f×Us×E=f×U.
12. How does frictional unemployment occur?
o A: Frictional unemployment occurs due to the time it takes workers to search for a
job.
13. What does the steady-state condition imply in terms of job separations and
findings?
o A: The number of employed people losing or leaving jobs equals the number of
unemployed people finding jobs.
14. How is the natural rate of unemployment affected by policy changes?
o A: A policy aiming to reduce the natural rate will succeed if it lowers ss or
increases ff.
15. What are the two main reasons why f<1f<1 in the context of unemployment?
o A: Job search and wage rigidity.
16. Define frictional unemployment.
o A: Frictional unemployment is caused by the time it takes workers to search for a
job, even when there are enough jobs available.
17. Why does frictional unemployment persist even with flexible wages?
o A: Frictional unemployment persists due to differences in worker abilities,
preferences, skill requirements of jobs, and imperfect geographic mobility.
18. What does the flow of information have to do with frictional unemployment?
o A: Frictional unemployment is affected by imperfect flow of information about
job vacancies and candidates.
19. How is the natural rate of unemployment related to the concept of job search?
o A: The natural rate is affected by the time it takes for workers to search for a job,
contributing to frictional unemployment.
20. Explain the concept of wage rigidity in the context of unemployment.
o A: Wage rigidity refers to the resistance of wages to adjust quickly, contributing
to the persistence of unemployment even in the presence of job opportunities.
Lesson 18
ISSUES IN UNEMPLOYMENT (CONTINUED)
MCQs:
1. What is the main cause of sectoral shifts leading to frictional unemployment?
a) Technological advancements
b) Changes in government policies
c) International trade agreements
d) Shifts in demand among industries or regions
Answer: d) Shifts in demand among industries or regions
2. Which sector experienced the highest percentage increase in GDP shares from 1969-
70 to 2003-04?
a) Agriculture
b) Manufacturing
c) Services
d) Other Industries
Answer: c) Services
3. How do smaller sectoral shifts contribute to unemployment in a dynamic economy?
a) By increasing demand for workers

b) By reducing frictional unemployment
c) By contributing to frictional unemployment
d) By decreasing the need for job training programs
Answer: c) By contributing to frictional unemployment
4. What is the purpose of government employment agencies in the context of

unemployment?
a) To reduce unemployment insurance benefits
b) To disseminate information about job openings
c) To increase the urgency of finding work
d) To limit job search activities
Answer: b) To disseminate information about job openings
5. How does unemployment insurance (UI) affect search unemployment?
a) It increases the opportunity cost of being unemployed
b) It reduces the urgency of finding work
c) It has no impact on search unemployment
d) It decreases the duration of unemployment spells
Answer: b) It reduces the urgency of finding work
6. According to studies, what is the relationship between the duration of

unemployment insurance and the average spell of unemployment?
a) There is no relationship
b) A positive relationship
c) A negative relationship
d) An inverse relationship
Answer: b) A positive relationship

7. What is a key benefit of unemployment insurance in terms of job matching?
a) It leads to higher wages for workers
b) It reduces worker productivity
c) It leads to better matches between jobs and workers
d) It increases the natural rate of unemployment
Answer: c) It leads to better matches between jobs and workers
8. What are the two main reasons for the existence of unemployment according to the
text?
a) Job search and wage rigidity
b) Minimum wage laws and efficiency wages
c) Labor unions and technological change
d) Sectoral shifts and government programs
Answer: a) Job search and wage rigidity
9. What is structural unemployment?
a) Unemployment caused by job search
b) Unemployment resulting from real wage rigidity and job rationing
c) Unemployment caused by minimum wage laws
d) Unemployment resulting from changes in government policies
Answer: b) Unemployment resulting from real wage rigidity and job rationing
10. Which factor does NOT contribute to wage rigidity?
a) Minimum wage laws
b) Labor unions
c) Efficiency wages
d) Technological change
Answer: d) Technological change
11. What is the main objective of labor unions?
a) To increase unemployment
b) To secure higher wages for their members
c) To decrease the equilibrium wage
d) To promote technological change
Answer: b) To secure higher wages for their members
12. According to efficiency wage theory, how do high wages affect worker productivity?
a) They decrease worker effort
b) They increase "shirking" among workers
c) They have no impact on productivity
d) They increase worker effort and reduce "shirking"
Answer: d) They increase worker effort and reduce "shirking"
13. What does the data show about the duration of unemployment spells?
a) Short-term spells are more common than long-term spells
b) Medium-term spells are more common than short-term spells
c) Long-term spells are more common than short-term spells
d) All spells have equal duration Answer: c) Long-term spells are more common than
short-term spells
14. What is the likely cause of long-term unemployment according to the text?
a) Structural and/or due to sectoral shifts
b) Changes in government policies
c) Efficiency wages
d) Decreases in the minimum wage

Answer: a) Structural and/or due to sectoral shifts
15. In the context of unemployment, what is the natural rate of unemployment?
a) The rate caused by structural unemployment only
b) The rate at which all workers are employed
c) The rate caused by job search only
d) The rate consistent with frictional and structural unemployment
Answer: d) The rate consistent with frictional and structural unemployment
16. What are the two explanations for the rise in European unemployment mentioned in
the text?
a) Changes in government policies and technological change
b) Generous social insurance programs and a shift in demand from unskilled to skilled
workers
c) Labor unions and minimum wage laws
d) Frictional unemployment and job search
Answer: b) Generous social insurance programs and a shift in demand from

unskilled to skilled workers
17. How did the increase in the minimum wage in the U.S. in 1996 affect unemployment
rates among teenagers?
a) It had no impact on unemployment rates
b) It decreased unemployment rates
c) It increased unemployment rates
d) It had different effects on different groups
Answer: c) It increased unemployment rates
18. What is the impact of wage rigidity on the distribution of jobs among workers?
a) It ensures an equal distribution of jobs

b) It results in job rationing among workers
c) It decreases the skilled-to-unskilled wage gap
d) It has no impact on job distribution
Answer: b) It results in job rationing among workers
19. According to the data, what is the unemployment rate of Pakistan in the year 2003?
a) 5%
b) 6%
c) 7%
d) 8% Answer: c) 7%
20. How does the U.S. handle the shift in demand from unskilled to skilled workers
compared to Europe?
a) By increasing unemployment rates
b) By implementing wage rigidity policies
c) By increasing the skilled-to-unskilled wage gap
d) By experiencing less impact due to less wage rigidity
Answer: d) By experiencing less impact due to less wage rigidity
Q&A:
1: What is sectoral shift in the context of unemployment?
A: Sectoral shift refers to changes in the composition of demand among industries or regions,
leading to shifts in employment patterns.
2: Provide an example of sectoral shift causing frictional unemployment.
A: An example is technological change increasing demand for computer repair persons and
decreasing demand for typewriter repair persons.
3: How do sectoral shifts contribute to frictional unemployment?

A: Workers take time to adapt to changes, causing frictional unemployment as they transition
between sectors.
4: What role do international trade agreements play in sectoral shifts?
A: International trade agreements can affect demand for workers, leading to changes in
employment patterns among export and import-competing sectors.
5: What are the industry shares in GDP for Agriculture, Manufacturing, Services, and
Other Industries in 1969-70?
A: Agriculture - 39%, Manufacturing - 16%, Services - 38%, Other Industries - 7%.
6: How have the industry shares in GDP changed from 1969-70 to 2003-04?
A: Agriculture decreased from 39% to 23%, Manufacturing increased from 16% to 18%,
Services increased from 38% to 52%, and Other Industries remained at 7%.
7: How do smaller sectoral shifts contribute to unemployment?
A: Smaller sectoral shifts contribute to frictional unemployment in a dynamic economy.
8: What is the role of government programs in addressing unemployment?
A: Government programs disseminate job information, match workers with jobs, and provide
training for workers displaced from declining industries.
9: How does Unemployment Insurance (UI) affect search unemployment?
A: UI increases search unemployment by reducing the opportunity cost of being unemployed and
the urgency of finding work.
10: According to studies, what is the relationship between the duration of UI eligibility and
the duration of unemployment spells?
A: The longer a worker is eligible for UI, the longer the duration of the average spell of
unemployment.
11: What are the benefits of UI in terms of job matching and productivity?
A: UI allows workers more time to search, leading to better matches between jobs and workers,
increasing productivity and incomes.
12: What are the two main reasons for unemployment according to the text?
A: Job search and wage rigidity are the two main reasons for unemployment.
13: Define structural unemployment and its causes.
A: Structural unemployment results from real wage rigidity and job rationing. Causes include
minimum wage laws, labor unions, and efficiency wages.
14: How do minimum wage laws contribute to unemployment, especially among teenagers?
A: If the minimum wage exceeds the equilibrium wage for unskilled workers, increases can lead
to higher unemployment rates among teenagers.
15: Explain the role of labor unions in causing unemployment.
A: Unions, by securing higher wages for members, can create unemployment when the union
wage exceeds the equilibrium wage.
16: What is the Efficiency Wage Theory, and how does it relate to unemployment?
A: Efficiency Wage Theory suggests that paying higher wages can increase worker productivity,
but it may also lead to unemployment.
17: What factors justify paying above-equilibrium wages according to the Efficiency Wage
Theory?
A: Factors include attracting higher quality applicants, increasing worker effort, reducing
turnover, and improving worker health.
18: What does the data show about the duration of unemployment spells?
A: More spells of unemployment are short-term, but most of the total time spent unemployed is
attributable to long-term unemployed.
19: Why is understanding the nature of long-term unemployment important for crafting
policies?
A: Understanding long-term unemployment helps in crafting policies that are more likely to
succeed in addressing persistent issues.
20: According to the text, what are the two explanations for the rise in European
unemployment?
A: The rise in European unemployment is attributed to generous social insurance programs and a
shift in demand from unskilled to skilled workers due to technological change.
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d. None of the above

Answer: c. Both a and b

2. Which of the following is a key economic variable studied in Macroeconomics?

3. What is the primary focus of Macroeconomics?

a. Study of individual markets

b. Study of aggregate economic variables

d. None of the above

Answer: b. Study of aggregate economic variables

d. None of the above

5. What is the objective of studying macroeconomics?

a. Understanding individual consumer choices

b. Learning how the national economy works

d. None of the above

Answer: b. Learning how the national economy works

6. Which of the following is a long-run economic variable?

Answer: c. Economic Growth

7. What does scarcity mean in economics?

c. Equal distribution of resources

d. None of the above

Answer: b. Limited resources

9. What is the cost of something in economics?

a. Its market price

b. Its production cost

c. What you give up to get it

d. None of the above

Answer: c. What you give up to get it

10. The word "economy" originates from a Greek word meaning:

Answer: b. Household management

11. What does rational decision-making involve in economics?

d. None of the above

a. Trade restrictions and free trade

b. Inflation and unemployment

c. Aggregate Demand and Aggregate Supply

d. Government budget deficit and surplus

Answer: b. Inflation and unemployment

c. By making rational decisions

d. None of the above

Answer: c. By making rational decisions

14. What is the primary focus of Microeconomics?

a. Aggregate economic variables

b. Individual markets and choices

d. None of the above

Answer: b. Individual markets and choices

15. What determines the standard of living in a country according to economic

Answer: c. Country's production

b. Usually a good way

Answer: b. Usually a good way

17. According to economic principles, when does the price rise?

a. During economic growth

b. When the government prints too much money

d. None of the above

Answer: b. When the government prints too much money

Answer: b. Direct relationship